, in the modern world, higher productivity enables an economy to grow even with a smaller working - age population, and hence to avoid the demographic trap. if a country can maintain a decent productivity growth even after it has exploited imported technology and an underutilized labor force, that country is likely to succeed in growing its way out of the middle - income trap. discussion of the myth of asian miracles also highlights the importance of total factor productivity. well before the asian currency crisis of 1997 – 1998, paul krugman argued that the rapid growth of the nies or asian tigers was not sustainable because their high growth was not sufficiently supported by total factor productivity. 8 history vindicated his assessment : the asian currency crisis was in part an inevitable transition toward more sustainable and balanced growth. let me confirm this point using data, with the usual disclaimer regarding the large uncertainty associated with estimates of total factor productivity. in graph 6, the vertical axis is per capita gdp growth, while the horizontal axis is total factor productivity growth. in the left panel, which describes the period preceding the asian currency crisis, the dots representing high growth asian economies are generally located well above the regression line. this means that their economic growth could be explained relatively more by expansion of inputs, such as demographic bonus and investment boom, than by total factor productivity growth. the right hand panel, which describes the situation in recent years, after the great financial crisis, shows that asian economies are much closer to the regression line than they were in the 1990s. this looks encouraging in terms of balanced growth. one caveat, however, is that asian dots are located closer to the zero - vertical line as well : total factor productivity growth is generally lower than it was in the 1990s. in other words, economic growth appears to be more balanced, but it may have also lost some strength. this is a bit disturbing because population aging is about to accelerate in some countries, with stronger demographic headwinds therefore to be expected. remember that once a country falls into demographic onus, it needs to offset negative demographic forces with higher growth in total factor productivity just to maintain per capita growth, and hence living standards. this is exactly why total factor productivity growth is the crucial issue for a number of asian economies. the next question then is, how do we raise total factor productivity growth? the answer may be a pessimistic one if we think that productivity growth is only exogenously determined. if this is the case, all we can do

, a mispricing of capital resulted in cheap funding and overinvestment. 11. developed economies are equally prone to the risks of mispriced capital. the subprime mortgage crisis, which precipitated the global financial crisis less than three years ago, is another example of mispriced capital leading to excessive risk taking and leverage. low interest rates in the us fuelled both a housing and a credit bubble that eventually burst, dragging down investors and intermediaries alike. 12. in emerging asia, today, high levels of domestic savings coupled with large capital inflows pose the risk of unproductive investments and asset bubbles. when capital inflows slow down, as they inevitably must, the consequent unwinding will be rapid and possibly unpleasant. asian policymakers have been responding to the situation in various ways 13. first, they have allowed the price of capital to rise – either through exchange rates or interest rates or both. second, they have regulated the demand for capital through fiscal tools, such as transaction taxes and stamp duties. third, they have regulated the supply of capital through administrative tools, ranging from restrictions on bank lending to selective capital controls. 14. the most effective way is to price capital correctly. several asian economies have been raising policy interest rates, though real interest rates still remain rather low. there has also been a fair amount of exchange rate appreciation. since mid - 2009, most regional currencies have appreciated by about 5 to 6 per cent in real effective terms. monetary policy in asia is likely to remain tight in the months ahead. this should help to get the price of capital right, tame asset price inflation, and reduce the risk of misallocated resources. 15. indeed, as emerging asia continues to grow, allowing the exchange rate to steadily appreciate over the medium term is vital to ensuring that capital inflows are moderated and capital is allocated to productive investments. 16. but interest rates and exchange rates cannot take the burden of adjustment entirely, especially over the short term, given the scale and pace of capital inflows. therefore, bis central bankers ’ speeches macroeconomic policy adjustments have been complemented in some asian countries by macroprudential measures, like reductions in banks ’ loan - to - value ratios and debt - to - income ratios. in exceptional cases, resort to capital flow management measures may be necessary to bring the situation under control. strengthen infrastructure for allocating capital 17. next, emerging