Presentation Script 0111

Module 01 Development & Development Policy Changes

Presentation Script

Frontiers of Development Policy

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Module 1: Development & Development Policy Changes Presentation Script

Development & Development

Welcome to the module on Development and Development Policy

Challenges.

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In this module:

Sustained economic growth is the most critical factor in alleviating

poverty, although the rate of poverty reduction differs from country to

country and also depends upon the initial level of income inequality, the

growth of inequality over time, the pattern of growth, and where that

growth is concentrated. Economic growth in developed and developing

countries will be our focus in this module. We will examine the growth

experience prior to and after the financial crisis of 2008, and we will look

at how economic growth can be made more inclusive.

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Developing countries: trend output remains de-coupled

Economic growth theory suggests catch up potential for developing

countries as they advance toward the high income efficiency frontier.

This assumes that pre-conditions for such growth catch up are largely in

place, including the realms of macroeconomics and institutions. In this

chart, we have the potential and cyclical components of GDP growth for

developing countries as a whole and advanced economies or high-income

countries. Potential, represented by the smoother lines in the chart,

captures underlying longer-term growth potential, while the cyclical

component, represented by the more volatile lines, captures how growth

tends to change (temporarily) over the economic cycle, with upturns and

downturns.

It can be seen from the chart that, while underlying growth in developing

countries has persistently diverged from, and generally far exceeded,

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underlying growth potential in high-income countries, the transitory

cyclical components of growth in both co-move more closely. The main

message is that developing countries have, over the past 50 years,

generally had higher underlying growth potential than high-income

countries, as might be expected from growth theory and the room for

catch up, but that growth co-moves within each business cycle. During

the recent crisis, and true to past patterns, the cyclical component of

growth in emerging countries has co-moved with that of high-income

countries, but underlying growth potential has remained higher in

developing countries.

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Continued better GDP growth in developing regions

This gap in output is stark from 2006 as we can see in this chart, with

developing countries, especially in Asia, outstripping high-income growth

for Japan, the US, the UK and the Euro Zone.

What are the reasons behind these differing growth experiences, and

what does it mean for the future? It is quite likely to related to underlying

improvements in developing country fundamentals-and the opposite in

high-income countries. We will look at these improvements in developing

countries during the remainder of this module.

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Factors behind growth record

What explains the differing growth series in the two previous charts? In

particular, what explains the consistently higher growth potential of the

developing countries, even after the great recession? How do we account

for the faster recovery in the developing regions, and here we include not

just China and India, Brazil and Turkey, but also those lower income

countries that have not faced political instability and have managed to

keep growing?

We suggest two inter-related reasons. The first is the structural change

that is taking place in the global economy, and the second is what we

categorize as a super economic global cycle that reached its apex in 2007

and has undergone a downward phase since then.

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Global structural change

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Super Economic global cycle

In addition to the structural change, there was the ascent and decline of

the global economy, characterized by a long and strong process of

leveraging of private portfolios in advanced economies, followed by a

process through which financial fragilities were built. The ascent was

marked by financial innovations and high levels of consumption based on

indebtedness and rising real estate values on the assets side. The nature

of this allowed the advanced economies to grow beyond potential while

making available an outlet space for increasing exports from Asia which

fed into increased global demand for natural resources, including higher

oil prices. This led to global imbalances, involving both the US and Europe

as the following two slides show.

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External imbalances

Here you can see the external current account imbalances across major

economic areas since 2000 with projections out to 2015. (It can be seen

that the World Sum line is rarely at zero, which means that there are

errors in some of the underlying measures. These total errors have,

however, narrowed considerably since 2000.)

What are the main patterns that we can see? First, the advanced country

G-20 member deficits, represented by the red bars, increased steadily

through 2008 and the sharp escalation of the global financial crisis after

Lehman. The counterpart was increased oil exporter and G-20 emerging

market surpluses. Since then, the advanced G-20 country deficits have

narrowed sharply, mainly on account of lower growth in these countries,

which tends to lower the value of their imports. The counterpart this

time has been a reduction in the current account surpluses of oil

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exporters and G-20 developing countries. With growth resuming in

advanced G-20 countries, external imbalances could, however, widen,

and there is no guarantee that global external imbalances have been

dealt with decisively.

Current account balance

A similar pattern took place in the Euro Zone. Since the inception of the

Euro Zone in 1999, the external current account deficits of Greece,

Ireland, Portugal, and Spain increased steadily through the crisis. The

counterpart was a steady increase in Germany's external current account

surpluses.

As in the previous slide, there has been a reversal of this pattern since

the crisis, with the external deficits of Greece, Ireland, Portugal, and

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Spain narrowing sharply after 2008 as growth and imports have fallen

and the fall of the German surplus.

Economic global cycle

Prior to the crisis, both public and private sector debt increased in both

Europe and the US. Since the crisis onset in 2007 and particularly since

the collapse of Lehman Brothers in late 2008, both Europe and the US

have deleveraged, or run down their debt, on the private sector side, but

with the public sector offsetting the economic impact of this by initial

expansionary policies and running up public debt.

On the public side, so far the U.S. Treasury can finance its high debt by

borrowing from investors at low interest rates, so the key issue driving

the need for austerity has stemmed from political, rather than economic,

pressures. In Europe, public debt has also increased, but only core

European countries have been able to continue borrowing at low interest

rates. Others, including the crisis cases, have seen interest rates increase

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markedly, forcing earlier fiscal austerity and tightening. Also in Europe, in

some countries, weakened banking sectors ended up being rescued by

government, adding to public debt burdens and further intensifying the

crisis.

Pre-crisis and post-crisis output in advanced economies

Recovery from deep financial crises tends to be slow and protracted. This

latest deep financial crisis is no exception.

As in past deep financial crises, economic recovery in advanced

economies has been sluggish. Added to this in Europe are the difficulties

associated with the ongoing fiscal austerity programs and banking

problems. Reflecting this, and as seen in the chart, advanced economies

have not recovered their loss of output, which looks likely to be

permanent, and growth is now somewhat lower than before the crisis.

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There is a permanent gap between the pre-crisis October 2007 WEO

growth projections and the mid-crisis growth projection. Growth

projections for advanced countries have worsened since then, meaning

that the slope of the solid line is now shallower, implying lower medium-

term growth.

Recovery in advanced economies a vicious cycle

In effect, there is a vicious cycle at play.

Briefly, the fiscal and debt problems in many high-income countries pose

risks to the public sector that could translate into plunging financial

markets (e.g., bond and stock markets), heavy losses for investors, and

public borrowing needs that some countries cannot meet without

outside financial support, in part because of weak banks who are now

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less willing to extend credit to public and private counterparts. This credit

squeeze, in turn, lowers economic growth that, in turn, leads to higher

unemployment, lower household spending, lower investment by firms,

increased savings to run down debt, and a vicious low-growth fiscal circle.

Toward a switchover of locomotives in the global economy

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Growth prospects in developing countries

Continuing from the chart mentioned in the video, we suggest some

sources of growth.

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Growth prospects in developing countries continued

We note that there is a low degree of leverage, for example balance

sheets, both public and private, that are in good shape in developing

countries as a whole. So there's scope for investment. For example, if

appropriate regulations are made for the proper appropriation of social

returns from investment in infrastructure, there's enough fiscal space to

make such investment economically viable.

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Secondly, there are opportunities for technological convergence. The

scope for this has been made easier where developing countries have

incorporated supportive policies in education, the regulatory framework,

and infrastructure. Even if the advanced economies remain stagnant at

the frontier, there is continued scope for developing countries to catch-

up. The advantage of the late-comer is very real.

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Third, for the first time, we may be witnessing a new dynamic with social

trickle-down of growth and rising middle classes.

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Fourth, developing countries present many opportunities for trade,

structural change, and global rebalancing of demand and supply.

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Developing countries are driving world trade

We note that many developing countries, particularly large countries in

Latin America and Asia, have had problems with industrialization in the

past.

In particular, the import substitution policies implemented by many Latin

American countries had well-known shortcomings, including lack of

competition, small domestic markets in some cases that didn't have the

scope for efficiencies that come with size, the wrong industries being

chosen to protect, and so on.

The Asian experience was better, but still did not match the

industrialization takeoff in Western Europe after World War II, where

industrialization was influenced by recovery after war, rapid

technological convergence, and the emergence of a large middle income

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group with corresponding mass consumption. However, as we noted, we

may be watching a similar movement now across developing countries as

a whole, as seen by the increased slopes of the lines in the left chart,

which show various measures of the increased shares of developing

countries in global trade. Developing countries also are now importing

more as their income increases, as seen in the chart on the right. It shows

that high-income shares in world imports has fallen sharply, and

developing country shares in world imports has, in contrast, risen sharply.

Natural resources as a blessing or a curse

Finally, we look at natural resources and whether they are a blessing or a

curse for economic growth.

The so-called resource curse refers to the counterintuitive finding that

countries with plenty of natural resources tend to suffer lower economic

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growth than countries with fewer natural resources. The major lesson

from the vast literature on the so-called resource curse is that reliance on

natural resources, even with high resource prices, can bring with it

problems that retard growth, including loss of competitiveness (the so-

called Dutch Disease), volatile public revenues as resource prices tend to

move about a lot, governance problems, and income inequality.

Looking ahead, and focusing on the higher commodity prices of late in

the chart, albeit with modest projected softening in the medium term,

there are grounds for hope that this resource curse may be addressed in

light of improved underlying economic fundamentals in developing

countries.

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Recap

We have a structural transformation taking place in the global economy

as witnessed by the growth in South-South trade and technological

improvements in developing countries. This structural change keeps on

happening, even as advanced economies linger with the legacy of their

own crisis. The major hope for the restoration of economic growth lies

with developing countries, as advanced economies do not look capable of

putting their house in order. This switchover of locomotives' is also

underpinned by some good news in developing economies, as a whole,

such as decreasing poverty and higher degrees of self-reliance. Of course,

this is not written in stone, but there are grounds for optimism,

particularly as developing economies have made huge strides in

implementing appropriate policies for growth and development and

show no attempt to change these.

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Key Message for Development and Development Policy

One of the key messages is that a rapid pace of growth is unquestionably

necessary for substantial poverty reduction and income growth. We refer

to this as the pursuit of inclusive growth,' or IG. It is concerned with both

the pace and pattern of growth and emphasizes the importance of

extensive and intensive growth.

A rapid pace of growth can be achieved through extensive growth, which

requires capacity expansion. In order to sustain this, there must be

periods when growth is intensive and accompanied by productivity

improvements and innovation. Thus, issues of structural transformation

rise to the fore. Inclusive growth takes a long-term perspective.

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Definition of Inclusive Growth

Now let's examine what we mean by the term inclusive growth' and how

we might craft related policies.

In order for inclusive growth to be sustainable in the long run, it should

be (1) broad-based across sectors, and, (2) inclusive of the large part of

the country's labor force. Inclusiveness refers to equality of opportunity

in terms of access to markets and resources, and an unbiased regulatory

environment for businesses and individuals.

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When Growth is Inclusive

Growth is inclusive when it is absolute pro-poor growth, or when the

poor benefit in absolute terms from economic growth. Thus, a society

aiming for absolute pro-poor growth would favor an outcome of 6

percent average growth even if the poor's incomes grew by 4%. Absolute

pro-poor growth can be the result of direct income redistribution

schemes, but for growth to be inclusive, productivity must be improved

and new employment opportunities created. Inclusive growth looks at

ways to raise growth by using more fully the parts of the labor force that

are trapped in low-productivity activities.

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Key differences between absolute pro-poor growth and IG

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Crafting IG strategies

Here are some of the areas one should target when crafting inclusive

growth strategies.

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Crafting IG strategies continued

We begin by targeting distortions and note that numerous distortions

exist at any time in a given country with varying degrees of importance. It

would be impossible to target all distortions, so one should target the

distortion with the largest direct welfare impact.

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Our main instrument for inclusive growth is productive employment, and

this should be targeted for inclusive growth. There is no bias in favor of

labor-intensive policies. What we need is productive employment; thus,

inclusive growth makes a distinction between self- and wage-employed,

employment by sector and size of firm, labor movements across sectors

and geographic areas, and movements from low to high productivity

sectors.

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We focus on fundamentals for growth, by which we mean a stable

macroeconomic environment, enforcement of property rights, openness

and effective government in crafting IG strategies, and an understanding

that these fundamentals interact differently with existing policies and

institutional setups in different countries.

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We focus on the individual as an economic actor and examine the factors

pertaining to labor demand and supply for the individual.

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Crafting IG strategies

Finally, we need to be mindful of the future constraints to growth that

may not be binding today but that may need to be addressed now in

order to achieve good future outcomes.

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Summary

The main message that arises from our consideration of how we might

craft policies for inclusive growth is that these policies must be country-

specific.

We know that the impact of policies for growth are highly dependent on

initial conditions, such as levels of income, poverty and asset inequality,

geography, demography, governance, politics, and the set of existing

policies. We know also that these characteristics differ across countries

and over time within the same country. Thus, policies for inclusive

growth need to be tailored to a country at a specific point in time.

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Summary continued

We consider three different types of economies in this slide and note the

form that policy for IG should take. For example, in situations of high but

jobless growth, strategies should focus specifically on inclusiveness, or,

more specifically, on equality of opportunity for individuals and

employability.

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Conclusion

You have reached the end of this module. You can continue learning by

accessing the next module.

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