Where Next for Developing Countries? – Future Prospects and Risks for South’s Economies
Despite adverse fallouts from the most severe post-war economic crisis and downturn in advanced economies (AEs), on average, developing countries (DCs) have so far managed to sustain an acceptable pace of economic growth for the reasons discussed above. Compared to the beginning of the crisis, total income in the developing world is now higher by almost one-third whereas AEs have barely managed to maintain their pre-crisis levels of income. Although growth in many major DCs is now considerably slower than the rates achieved before the onset of the crisis, there are widespread expectations, notably among policy makers, that prospects are brighter in the coming years, once the worst post-war crisis is fully overcome, economic activity is stabilized and employment and output gaps are reduced in AEs. These would allow DCs to go back to catch-up growth and continue to converge towards income levels of AEs, very much as in the period before the onset of the crisis.
There are, however, important question marks regarding these expectations. First, it is not clear when the crisis will be over and if DCs can sustain a reasonable pace of growth in the event of protracted instability and weakness in AEs. There are still serious downside risks, notably from the Eurozone (EZ) and China, and global economic conditions could worsen before starting to improve. Second, the exit of AEs from the crisis may not necessarily improve global economic environment in all areas that affect the performance of DCs. AEs may not be able to move to a high and stable growth path and global financial conditions may tighten considerably with their exit from the ultra-easy monetary policy. Third, growth prospects of most DCs also depend crucially on China. Although China has withstood severe fallouts from the crisis, there is considerable uncertainty whether it can maintain strong growth over the longer term.
Downside risks
No doubt the EZ is now the Achilles’ heel of the global economy and the immediate threat to stability and growth in DCs. Although financial stress in the region has declined considerably, adjustment fatigue or political turmoil in the periphery could still deepen the crisis and even lead to a total break up. However, it is difficult not only to predict the evolution of the EZ in the coming years, but also the impact of a break-up, since past economic and financial linkages would provide little guide for estimating the consequences of such an unprecedented event. Still, even without a total break-up, an intensification of financial stress could have serious repercussions for DCs, as suggested by various downside scenarios simulated by the IMF, the UN and the Organisation for Economic Co-operation and Development (OECD).
Financial contagion to DCs from a major turmoil in the EZ, notably a default and exit, could be much more serious than adverse spillovers through trade because it would affect balance sheets and be more difficult to handle with standard macroeconomic policy tools. The main channel would be capital flows, asset prices and exchange rates, which have already become highly sensitive to news from the EZ, as noted. The impact could be similar to that triggered by the collapse of Lehman brothers in 2008 – a flight to safety, stronger dollar and sharp declines in assets and currencies in DCs. It could be longer lasting than Lehman, because of difficulties in restoring confidence and stability.
The outlook of the global economy is also clouded by downside risks surrounding China. It has been increasingly argued, including by a prominent Asian investment bank, Nomura Holdings Inc., that because of the credit and property bubbles created by its response to fallouts from the crisis, China now displays the symptoms that the US showed before the sub-prime crisis. On this view, if a loose policy stance is maintained and the risks are not brought under control, strong growth above 8 per cent could be attained in 2013, but only to be followed by a financial crisis as early as 2014 (Wall Street Journal, 2013; Frost, 2013). Again, a global survey of fund managers conducted in March 2013 has shown widespread expectations of a hard landing in China (Emerging Markets, 2013). The loss of growth momentum in the first quarter of 2013 has also renewed fears of an imminent crisis in the banking system.
The impact of a financial turbulence in China on DCs could be more serious than that of a sharply increased financial stress in the EZ. It can be expected to lead to a sudden reversal of capital inflows, a sharp correction in asset markets and strong downward pressures on the currencies in the developing world. Such adverse financial spillovers would be aggravated by the impact of a sharp drop in China’s demand for commodities. Consequently, DCs heavily dependent on capital flows and commodity exports are particularly vulnerable to a financial turbulence and a hard landing in China.
However, a severe financial stress in China does not have a high probability of occurrence. As argued by Anderlini (2013), even if the risks are not (or could not be) immediately brought under control, in China “a Lehman style collapse is impossible” and its “banking system is more likely to undergo slow erosion” because of extensive state ownership and guidance.
Longer-term prospects
In considering the longer-term prospects for the global economy, the prospects for the US and Europe are of course crucial. This has already been analysed in the pervious issue of the South Bulletin. We now consider the situations of China.
The response of China to fallouts from the crisis has served to rebalance domestic and external demand, but aggravated the imbalance between investment and consumption, which had already been building up in the period before the crisis. Investment has been the main driver of growth since 2009 and consumption has been growing only marginally faster than income. However, China cannot keep on pushing investment to fill the deflationary gap created by the slowdown in exports in conditions of exceptionally low shares of wages and household income in GDP. That would add more to financial fragility and imbalances than to productive capacity and potential growth. Nor can it go back to export-led growth and constantly increase its penetration of foreign markets. This would be resisted, possibly causing disruptions in the trading system.
Regardless of how the existing financial fragilities created by the credit and investment bubbles are handled, the most likely medium-term scenario for China is a sizeable drop in its trend growth compared to double-digit rates it enjoyed in the run-up to the crisis, with a better balance between domestic and external demand and a gradual rebalancing of domestic consumption and investment. Indeed, research conducted at the Chinese Development Research Centre on growth prospects of China is reported to have concluded that, for a number of reasons on the demand and supply sides, such a transition to slower growth is already under way and the growth rate is expected to come down to 6.5 per cent during 2018-22 after three decades of double-digit levels (Wolf, 2013). However, the possibility that China may also get caught in a middle-income trap is not excluded (Bertoldi and Melander, 2013; ADB, 2011).
The transition of China to a lower growth path over the next few years implies that its demand for commodities would grow much more slowly than in the past decade. This would result not only from slower growth but also rebalancing of demand towards consumption, which is much less import intensive than either exports or investment (Akyüz, 2011a). Improvements in the efficiency in the use of materials could also reduce the pace of China’s demand for materials (UNEP, 2013). Together with a stronger dollar, these could imply significant loss of momentum in commodity prices, short-circuiting the commodity super-cycle and lowering its mean in conformity with the observed historical pattern (Erten and Ocampo, 2012).
Nor can China be expected to become a locomotive for exporters of manufactures in the developing world. Its imports of manufactures from DCs have so far been destined mainly for exports rather than for domestic consumption which has very low import content (Akyüz, 2011a). A more balanced growth between exports and domestic consumption would imply slower growth of imports of parts and components from other DCs. On the other hand, there is still some time before China could exit from labour-intensive, low-skill manufactures and become a major market for lesser developed countries in these products, relocating such industries, à la Flying Geese, in lower-cost countries in South and South East Asia and Africa.
Conclusions
The crisis in AEs has aggravated the problem of underconsumption that the world economy has been facing due to low and declining share of wages in income and increased concentration of wealth. Rising inequality is no longer only a social problem. It has also become a serious macroeconomic problem, compromising the ability of the world economy to achieve strong and sustained growth and financial stability. The solution calls for strong action on its causes – financialization, the retrenchment of welfare state and globalization of production. However, the likelihood of fundamental changes in these areas is slim. Thus, the post-crisis world economy may either go back to finance-driven boom-bust cycles, enjoying unsustainable expansions followed by deep and prolonged crises, or may have to settle at a slow growth path. It is against this background that DCs need to rethink their development policies.
Not only has the “Great Recession” led to a “Great Slowdown” in DCs (Economist, 2012), pushing growth rates possibly below stalling speeds in some, but also medium-term prospects for global economic conditions look unfavourable compared to pre-crisis years and, in some respects, even compared to the period since the onset of the crisis. Thus the rapid rise of the South that began in the early years of the new millennium appears to have come to an end. This should not come as a surprise since, as argued in Akyüz (2012), the exceptional performance of DCs in the run up to the crisis was driven primarily by exceptional global conditions. There were little signs of tangible improvements in the underlying growth fundamentals or dynamics in DCs experiencing acceleration.
That acceleration took place without any significant progress in industrialization without which most DCs cannot converge and graduate to the levels of productivity and living standards of AEs. Of the so-called BRICS (Brazil, Russia, India, China and South Africa), only China promises sustained catch-up growth and graduation even though it faces a bumpy road. Brazil, Russia and South Africa continue to depend heavily on commodities and have indeed deepened their dependence by expanding the commodity sector relative to industry. The two key determinants of growth in Latin America and Africa, commodity prices and capital flows, are largely beyond national control and susceptible to sharp and unexpected swings. At a bare 3 per cent, the average potential growth rate of Latin America is far too low, even if constantly realized, to close the income gap with AEs. Many second-tier Newly Industrializing Economies (NIEs) in Asia seem to be caught in the middle-income trap, facing growing competition from below without being able to upgrade and join those above – the first-tier NIEs and Japan. India has been relying on the supply of labour to the rest of the world, not by converting them into higher-value manufactures, but by exporting unskilled workers and IT and other labour services of a very small proportion of its total labour force (Nabar-Bhaduri and Vernengo, 2012).
As one development practitioner has put it, for DCs it would now be “unwise to count on tail winds; they will likely weaken, become more volatile, or both” (Torre, 2013). The remarkable performance of most DCs in the past decade is in danger of remaining a “one-off success” unless they raise productive investment, accelerate productivity growth and make significant progress in industrialization. Globalization has been oversold to DCs. They have largely left their development to international market forces shaped mainly by policies in AEs and their financial conglomerates and transnational corporations in control of international production chains.
Despite growing disillusionment in the South, the Washington Consensus is dead only in rhetoric. There is little roll back of policies pursued and institutions created on the basis of that consensus in the past two decades. On the contrary, the role and impact of global market forces in the development of DCs has been greatly enhanced by continued liberalization of trade, investment and finance unilaterally or through bilateral investment treaties and free trade agreements with AEs. DCs need to be as selective about globalization as AEs, and reconsider their integration into the global economic system, in recognition that successful industrialization is associated neither with autarky nor with full integration, but strategic integration designed to use foreign markets, technology and finance to pursue industrial development.
This implies rebalancing external and domestic forces of growth and development. Since the end of the so-called import-substitution, inward-oriented policies, the pendulum has swung too far. Dependence on foreign markets and capital should be reduced. There is also a need to redefine the role of the state and markets, not only in finance but also in all key areas affecting industrialization and development, keeping in mind that there is no industrialization without active policy.
