WASHINGTON, DC – The world economy has just been through a severe recession marked by financial turmoil, large-scale destruction of wealth, and declines in industrial production and global trade. According to the International Labor Organization, continued labor-market deterioration in 2009 may lead to an estimated increase in global unemployment of 39-61 million workers relative to 2007. By the end of this year, the worldwide ranks of the unemployed may range from 219-241 million – the highest number on record.
Meanwhile, global growth in real wages, which slowed dramatically in 2008, is expected to have dropped even further in 2009, despite signs of a possible economic recovery. In a sample of 53 countries for which data are available, median growth in real average wages had declined from 4.3% in 2007 to 1.4% in 2008. The World Bank warns that 89 million more people may be trapped in poverty in the wake of the crisis, adding to the 1.4 billion people estimated in 2005 to be living below the international poverty line of $1.25 a day.
In this climate, globalization has come under heavy criticism, including from leaders of developing countries that could strongly benefit from it. President Yoweri Museveni, who is widely credited for integrating Uganda into world markets, has said that globalization is “the same old order with new means of control, new means of oppression, new means of marginalization” by rich countries seeking to secure access to developing country markets.
Yet the alternative to global integration holds little attraction. Indeed, while closing an economy may insulate it from shocks, it can also result in stagnation and even severe homegrown crises. Current examples include Myanmar and North Korea; before their economic liberalization China, Vietnam, and India were in the same boat.
To ensure a durable exit from the crisis, and to build foundations for sustained and broad-based growth in a globalized world, developing countries in 2010 and beyond must draw the right lessons from history.
In the current crisis, China, India, and certain other emerging-market countries are coping fairly well. These countries all had strong external balance sheets and ample room for fiscal maneuver before the crisis, which allowed them to apply countercyclical policies to combat external shocks.
They have also nurtured industries in line with their comparative advantage, which has helped them weather the storm. Indeed, comparative advantage – determined by the relative abundance of labor, natural resources, and capital endowments – is the foundation for competitiveness, which in turn underpins dynamic growth and strong fiscal and external positions.
By contrast, if a country attempts to defy its comparative advantage, such as by adopting an import-substitution strategy to pursue the development of capital-intensive or high-tech industries in a capital-scarce economy, the government may resort to distortional subsidies and protections that dampen economic performance. In turn, this risks weakening both the government’s fiscal position and the economy’s external account. Without the ability to take timely countercyclical measures, such countries fare poorly when crises hit.
To pursue its comparative advantage and prosper in a globalized world, a country needs a price system that reflects the relative abundance of its factor endowments. Firms in such a context will have incentives to enter industries that can use their relatively abundant labor to replace relatively scarce capital, or vice versa, thereby reducing costs and enhancing competitiveness. Examples include the development of garments in Bangladesh, software outsourcing in India, and light manufacturing in China.
But such a relative price system is feasible only in a market economy. This is why China – which appears to be faring well in the crisis, meeting its 8% growth target in 2009 – became an economic powerhouse only after instituting market-oriented reforms in the 1980s. Indeed, all 13 economies with an average annual growth rate of 7% or more for 25 years or longer, identified in the Growth Commission Report led by Nobel laureate Michael Spence, are market economies.
Pursuing its comparative advantage strengthens a country’s resilience to crisis and allows for the rapid accumulation of human and physical capital. Developing countries with such characteristics are able to turn factor endowments from relatively labor- or resource- abundant to relatively capital-abundant in the span of a generation.
In today’s competitive global marketplace, countries need to upgrade and diversify their industries continuously according to their changing endowments. A pioneering firm’s success or failure in upgrading and/or diversifying will influence whether other firms follow or not. Government compensation for such pioneering firms can speed the process.
Industrial progress also requires coordination of related investments among firms. In Ecuador, a country that is now a successful exporter of cut flowers, farmers would not grow flowers decades ago because there was no modern cooling facility near the airport, and private firms would not invest in such facilities without a supply of flowers for export.
In such chicken-and-egg situations, in which the market alone fails to overcome externalities and essential investments go lacking, the government can play a vital facilitating role. This may be one of the reasons why the Growth Commission Report also found that successful economies all have committed, credible, and capable governments.
The world is now so far down the path of integration that turning back is no longer a viable option. We must internalize lessons from the past and focus on establishing well-functioning markets that enable developing countries fully to tap their economies’ comparative advantage. As part of this process, a facilitating role for the state is desirable in developing and developed economies alike, although the appropriate role may be different depending on a country’s stage of development.
Ultimately, in today’s complex and interlinked world, even the most competitive economies need a helping hand as they climb the global ladder.