Wednesday, July 30, 2014
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Can Developing Countries Carry the World Economy?

CAMBRIDGE – In the early days of the global financial crisis, there was some optimism that developing countries would avoid the downturn that advanced industrial countries experienced. After all, this time it was not they that had engaged in financial excess, and their economic fundamentals looked strong. But these hopes were dashed as international lending dried up and trade collapsed, sending developing countries down the same spiral that industrial nations took.

But international trade and finance have both revived, and now we hear an even more ambitious version of the scenario. Developing countries, it is said, are headed for strong growth, regardless of the doom and gloom that has returned to Europe and the United States. More strikingly, many now expect the developing world to become the growth engine of the global economy. Otaviano Canuto, a World Bank vice president, and his collaborators have just produced a long report that makes the case for this optimistic prognosis.

There are many reasons why such optimism is not unreasonable. Most developing countries have cleaned up their financial and fiscal houses and do not carry high debt. Governance is generally improving along with the quality of policymaking. The possibilities of technology transfer through participation in international production networks are greater than ever.

Moreover, slow growth in the advanced economies need not exert a drag on developing countries’ performance. Long-term growth depends not on foreign demand, but on domestic supply. Sustained rapid growth is the result of poorer countries catching up to rich countries’ productivity levels – not of growth in the rich countries themselves. For most developing countries, this “convergence gap” is wider now than it has been at any time since the 1970’s. So the growth potential is correspondingly larger.

But the good news stops right about there. Sustained growth requires a growth strategy, and most developing countries do not yet have one that would put them irrevocably on the path of economic convergence.

For too many of these countries, economic growth in the last two decades relied on a combination of two factors: a natural rebound from previous financial crises (as in Latin America) or political conflicts and civil war (as in Africa), and high commodity prices.  Neither can be relied on for the productive transformation that developing countries need. 

Consider, for example, Latin America’s growth model of the last two decades. Global competition has whipped many of the region’s industries into shape and fostered significant productivity gains in advanced sectors, but these gains have remained limited to a narrow segment of the economy.

Worse still, labor has been displaced from more productive tradable activities (in manufacturing) to less productive informal activities (services). In most Latin American countries, structural change has served to reduce rather than promote economic growth.

Because Asian governments have tended to support their modern, tradable sectors to a greater extent, most Asian countries have managed to avoid this malady, and have done much better as a result. But even the Asian model may be reaching its limits.

China, in particular, needs to confront the fact that the rest of the world will not allow it to run a huge trade surplus forever. An undervalued currency, which serves to subsidize China’s manufacturing industries, has been a key driver of the country’s economic growth for the last decade. A significant appreciation of the renminbi will reduce or even eliminate that growth subsidy.    

Regardless of developing countries’ growth prospects, there is a deeper question. Will a world economy in which developing countries have substantially greater weight foster the kind of global governance that sustains a hospitable economic environment? Emerging-market economies have not yet shown the kind of global leadership that suggests an affirmative answer to this question.

The global institutions of our day – the International Monetary Fund, the World Bank, and the World Trade Organization – are still largely the creation of American leadership at the end of World War II (though they have obviously undergone considerable change since then). These institutions reflected American interests, but they also codified certain norms of behavior – rule-based decision-making, non-discrimination, multilateralism, transparency – which eventually came to constrain American power as well.

Countries like Brazil, China, India, and South Africa, however, have so far shown little interest in contributing to the construction of global regimes, preferring to remain free riders. Jorge Castañeda, a former foreign minister of Mexico, goes further, arguing that these countries have systematically opposed global rules, in areas ranging from climate change to international trade.

Lest we be too harsh on developing countries, however, let us also remember that political scientists have long worried that greater diffusion of economic power would produce a less stable world economy. If the world economy’s center of gravity shifts substantially toward developing countries, this will not be a smooth – and possibly not even a benign – process.

We can be certain of two things: only those countries that adopt growth strategies based on stimulating domestic structural change will do well, and the conundrum of global governance – how to manage a world economy that has become unruly – will almost certainly get worse.

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