Fiscal agencies, including the Australian Treasury, routinely make long-term projections of their respective economies to better inform policymakers on the key determinants of future economic well-being.2F3 For a small open economy, such as Australia, international trade is an important determinant of economic growth. As such, a well-thought-out projection of the long-term growth of the Australian economy must in turn consider the long-term outlook of its trading partners. This paper responds to that challenge by developing a framework for projecting GDP growth of Australia’s trading partners over the period from 2012 to 2050.
Economists have long grappled with the question of why some countries grow faster than others. The literature on growth and development is rich with theories of the determinants of economic growth. The dominant paradigm is the neo-classical growth model which assumes growth is determined in the long run by the growth of the labour force and an exogenous factor called labour augmenting technical change (that is, labour productivity net of capital deepening). This theory has been modified over time to allow the level of labour augmenting technology to vary across countries according to observable characteristics identified by the vast empirical growth literature as being statistically and economically significant (see the extensive survey by Barro and Sala-i-Martin, 2004). In this sense, the convergence framework is conditional rather than absolute, as countries’ steady-state (or long-run) productivities are allowed to vary depending on the individual characteristics of each country.
The projection framework adopted here draws heavily on the existing conditional growth literature, including long-standing estimates of key convergence parameters. Even with the benefit of a large amount of research in this area, it remains a challenge to determine (and compile the data for) the factors that should be used in estimating each country’s long-run relative productivity. We overcome this problem by using the World Economic Forum’s Global Competitiveness Index (GCI) — a single metric that attempts to capture the multitude of factors affecting a country’s long-run productivity. In essence, we view the GCI as an ordinal proxy for long-run relativities in productivity between countries, and use non-parametric methods to estimate a relationship between the GCI and actual productivity. For countries away from their steady state, this estimated relationship allows us to make cardinal predictions of their long-run productivity relative to the benchmark country (which is the United States).
The remainder of the paper is organised as follows: Section 2 describes the theory underlying the empirical conditional growth model; Section 3 describes the data underlying the empirical model’s parameters and long-term GDP projections; Section 4 details the methodology used in estimating key convergence parameters; Section 5 reports long-term international GDP projections; and Section 6 summarises the key findings and outlines future research projects.
3 Long-term international GDP projections have contributed to recent Australian Government documents, including the Australia in the Asian Century: White Paper (see Australian Government, 2012, for details).