If Thailand hopes to return to economic growth rates of at least 5 to 6 per cent a year in the medium term, it will need to achieve productivity of 3 to 4 per cent a year, according to a report by the International Monetary Fund.

This drive toward productivity growth, however, will require Thailand to maintain an open trade and investment regime, as well as to invest more in human capital, said the IMF report prepared by its staff in the Asia-Pacific Department and published on July 18 this year.

Thai policy-makers have so far placed little emphasis on TFP (total factor productivity) as a tool to measure the efficiency of the economy through input factors (normally capital and labour) and output. But the IMF report suggested that for output growth to become sustainable, it should be driven by technological development rather than by capital accumulation or employment growth.

In the medium term, the IMF report projected a Thai economic growth rate of 5 to 6 per cent. But for Thailand to achieve this growth rate, it will have to achieve TFP growth of about 3 to 4 per cent a year, since capital accumulation is not going to expand as it did in the 1980s or the early 1990s.

Capital or investments cannot be piled up for ever without being matched by efficiency gains. Before long, capital accumulation will inevitably experience diminishing returns. Besides, employment growth cannot be added into the economy for ever in a sustainable way.

The IMF projected Thailand's gross investment in the medium term to grow at 8 to 9 per cent. However, most investment going forward is expected to replace the depreciated capital. While the net capital accumulation is expected to be lower (about 2 to 3 per cent), employment growth is projected at about 2 per cent.

"A principal finding is that in the future economic growth would have to be driven by higher TFP growth," said the IMF report. "The high growth rates of the pre-crisis period were driven by capital accumulation rather than TFP growth. Indeed growth slowed during the 1990s. As capital accumulation is expected to remain modest in the medium term, economic growth will have to be increasingly driven by higher TFP growth and, to a lesser extent, employment growth."

Technically, TFP growth can be measured as the difference between growth in output and growth in labour and capital for given estimates of the technological factor shares. The IMF report suggested that the high rate of output growth in Thailand during the 1980s and early 1990s was mainly driven by capital accumulation, and to a lesser extent by TFP growth.

As the chart clearly shows, Thailand's annual growth rates of about 8 per cent between 1981 and 1996 were driven largely by capital accumulation (adding new money or investment into the economy). But TFP growth was also quite impressive, averaging about 4 per cent a year between 1981 and 1996, largely due to Thailand's maintenance of openness in trade and foreign investment.

TFP collapsed into negative growth between 1997 and 2000, the period of the economic crisis.

However, Thailand's accumulation of capital was found to be substantially higher than in other Asian countries in the early 1990s, although its capital output ratio was lower than elsewhere.

In his report entitled "How the Baht Float Will Lead to a Restructuring of the Thai Economy", presented on July 6, 1997, Bangyong Pongpanit, the former investment banking chief at Phatra Thanakit Plc, also reached a similar conclusion. He was the first Thai analyst to have pointed out the unsustainable growth of the Thai economy, which had been facing diminishing returns from massive investment in the years running up to the 1997 crisis.

Banyong found that Thailand's investment boom, which took off around 1987, was not matched by capital output. In other words, Thai companies hardly made a profit and could not service their debts from the massive investment they poured into the economy. New capital, buoyed by optimistic forecasts of the potential of the economy, kept clouding this underlying trend.

Indeed, Bangyong found that the incremental capital output ratio had begun to decline even before 1990 (see table). An economic crisis is the inevitable result of a mismatch between investment and returns.

For Thailand's outlook in the medium term, the IMF report suggested that the policy thrust should focus on raising productivity growth rather than capital and labour accumulation. It further called for Thailand to maintain an environment conducive to efficiency gains and technological development.

"Factors that appear crucial in contributing to such a development include preserving an open trade and investment regime, further emphasis on education and skills development, the implementation of initiatives to stimulate research and development activities and the adoption and diffusion of information technology," the IMF report said.

Thanong Khanthong