1996APEC economic outlook EXECUTIVE SUMMARY

The purpose of this report is to elucidate both recent developments in the APEC region and the long-term determinants of growth. The first part of the report examines trends and policies of each individual member. Part II of the report examines how resources can be most efficiently mobilized to spur long-run growth. Drawing on both theory and evidence, the report explores three components of growth: labor force development, physical capital investment, and total factor productivity.With a combined annual income of over $13 trillion, the 18 member economies of the Asia Pacific Economic Cooperation (APEC) accounted for approximately 55 percent of total world income and 40 percent of global trade in 1995. According to the World Bank, growth in the East Asian developing economies is projected to average 8 percent per year over the next decade, contributing to strong growth in APEC as a whole. With this dynamic performance, the APEC region will continue to increase its importance in the world economy.

For the region as a whole, the indicators for 1995 were positive and robust growth continued. Overall inflation has fallen to 6.3 percent; the APEC-wide central government deficit fell to 1.8 percent of GDP; and the current account deficit stabilized at 0.7 percent of GDP. Yet, the aggregate numbers conceal differences within the region.

The 1995 inflation rate of -0.1 percent in Japan, for example, contrasts sharply with the inflation rate of 52 percent in Mexico. Monetary policy in Chile, Hong Kong, Indonesia, Mexico, New Zealand, and Thailand has been tight, while real interest rates have moved to lower levels in the U.S. and Canada over the last year. Japan continues to run a declining current account surplus whereas economies such as Malaysia and Thailand, with large infrastructure development programs, have significant deficits.

These short-run macroeconomic trends, however, may be less important to living standards than long-run growth, which is a function of growth in labor and capital inputs and improvements in productivity.

Labor force developments can contribute to higher output in two ways: through more workers (quantity of the labor force), and through more output per worker (labor productivity). Numerous studies suggest a causal link between education and labor productivity. Economies with better educated workers tend to grow faster. Studies document that economies with the highest initial levels of education in the 1960s grew fastest in the ensuing decades. Notably, the higher-performing Asian economies spent a larger fraction of their GDP on primary education than other APEC members.

Growth rates are also affected by levels of labor force participation. As incomes grow, hours per worker tend to decline; to ensure continued growth in labor input, labor force participation must increase. In the economies of East Asia and the Pacific, increased labor force participation accounted for almost a third of growth in the 1980s; in the United States, increased participation accounted for over half the growth in total output between 1981 and 1995. Falling transportation costs, the removal of discriminatory barriers to women's participation, and increased provision of child care are all correlated with increased labor market participation.

Although the share of output contributed by physical capital is smaller than the share contributed by labor, capital investment is also critical to growth. Capital investment affects growth rates directly, by increasing the capital-labor ratio, and indirectly, by stimulating technical progress and productivity gains. Empirically, there is a positive correlation between the strength of investment and the dynamism of growth. Notably, in the most rapidly growing members of APEC, the share of output devoted to investment exceeds 30 percent.

Although investment has been primarily undertaken by the private sector, public sector reforms have been crucial in fostering a stable environment for private investment and in stimulating infrastructure development. Public policies have encouraged foreign investment by maintaining prudent exchange rates, low tariffs, and an open-oriented economy. Fiscal responsibility and positive real interest rates have boosted savings, providing the primary source of financing for domestic investment.

The final component of growth, total factor productivity, is the portion that cannot be attributed to labor or capital. Total factor productivity growth, while difficult to measure, stems from technological innovation, resource reallocation to more productive sectors, and increasing returns to scale. There are many ways for governments to support total factor productivity growth, including promoting research and development, establishing pro-competitive market policies, expanding trade, and encouraging foreign direct investment.

Growth as it is conventionally measured does not adequately capture a population's sense and state of well-being. As the Osaka Action Plan emphasizes, the goal of the APEC members is to support sustainable growth and equitable development. Growth that exhausts resources and constrains options for future development paths is not consistent with this goal. The value of many resources -- such as fish populations, clean air, and forests -- is not appropriately priced in the market; the result is often over-harvesting, degradation, and denudation. This report examines various efforts to establish environmental and agricultural policies in an effort to promote sustainable growth and sufficient food for a growing population. The report points to the benefits of market-based policies that correct for market imperfections in the pricing of environmental goods.

The report is intended to help policy-makers understand the sources of growth as well as the importance of sustainable growth. The ultimate objective of economic policies is to raise living standards, and higher sustainable growth is the key to higher living standards. The APEC process can contribute to better living standards by promoting the sources of sustainable growth through trade, investment and cooperation.