We are living in a world in which developed economies are close to their natural limits of growth. These limits occur for demographic reasons and they exist because of limits on productivity growth. The developed world is experiencing a demographic depression.

Population growth is slow or non-existent. This reduces potential GDP growth. In the developed world, most of the working population is already deployed in industries where they can generate the highest level of output per person. The potential for accelerated productivity growth, because of people entering these industries, is low.

In countries like Germany and Japan, growth is limited to only the annual growth in productivity of those people who are already employed in industries where they are already achieving the highest level of output per person. This means that the average growth rate of Germany is only 1.2 per cent. In Japan, the average growth rate is only one per cent.

The situation in emerging economies is quite different. Population growth rates vary. The population growth rate of China is slow. The population growth rate of India and Brazil is fast. What is the case in all of these economies is that so far only a small proportion of the total population is already working in industries where they can generate the highest level of output per person.

The majority of people in each of these economies are still working (if they are working at all) in a situation where there are low levels of capital per worker and the output of those workers is low. As those people move into industries where there is a high amount of capital per worker, and those workers produce a much higher level of output per person, those economies appear to grow rapidly because of high gains in productivity.

The result of this difference can be seen by the different growth outlooks for developed economies and the emerging economies over the next two years. In 2010 and 2011, we think that the US economy will grow by 2.6 per cent and then by 2.2 per cent.

This is only around or slightly higher than the long-term average growth rate of 2.2 per cent. Germany, which is recovering at around 3.7 per cent in 2010, should slow to a growth rate of 1.9 per cent in 2011. Japan, which is recovering at three per cent in 2010, should slow to a growth rate of only 1.5 per cent in 2011.

Compare this to China and India. In 2010, China, which is achieving a soft landing from a property boom in 2009, should still produce 9.9 per cent growth in 2010. This should be followed by nine per cent growth in 2011. Indian growth is almost as good. India should grow at 8.3 per cent in 2010 and 8.3 per cent again in 2011. This high level of growth is putting upward pressure on inflation in both countries. The price level should rise by 9.5 per cent in India in 2010. However, that inflation growth should fall to 6.8 per cent in 2011. China has its inflation more in control with three per cent inflation in 2010, followed by 3.1 per cent inflation in 2011.

Australia is almost ideally situated as a supplier of exports to both China and India. Our growth rate should be at above trend of 4.2 per cent in 2010 followed by 3.7 per cent in 2011. We are like China and India, rather than Japan and Germany. Our problems are more like emerging world problems. One of those problems is upward pressure on prices. We think inflation will growth by 3.5 per cent in 2010 and 2.75 per cent in 2011. This is at the upper end of the RBA’s preferred inflationary range. This means that the RBA is likely to gradually increase interest rates in response to this inflationary pressure.

The outlook for the Australian economy is strong in 2010 and 2011. The problems that we have are like the problems of an emerging economy. With strong growth comes inflationary pressure.

These problems are probably good problems to have.

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