Developing world needs to get smart
In the event of large outflows of capital, countries should be prepared to impose exchange restrictions.
There are numerous reasons to believe that the forces that have been driving growth in developing and emerging economies since 2009 cannot be sustained over the medium term.
At the same time, it is impossible to return to the extremely favourable international economic conditions that prevailed before the eruption of the global crisis. This means that unless there are fundamental changes in the way these countries are integrated into the world economy, the stunning recent ascent of the South may prove to be a passing phenomenon, and the speed of its convergence with the income levels of advanced economies may slow considerably in the coming years.
Developing countries face two interrelated challenges, which demand a rethinking of their strategies: in the immediate future, they face the risk of a significant drop in their growth rates, which could be quite severe if the European recession deepens, bringing down the US. Second, in the medium term they cannot go back to the kind of growth they enjoyed during the subprime expansion even if the advanced countries succeed in recovering fully and settling on a rigorous and stable growth path.
Developing countries now have a narrower policy space for a countercyclical response to deflationary and destabilising impulses than they had after the Lehman collapse in September 2008. In the past few years, fiscal and external imbalances have widened significantly in many emerging economies. Despite this, they need to deploy all possible means to prevent a sharp slowdown of economic activity and a hike in unemployment.
Many developing and emerging economies, notably in Latin America, have some manoeuvring room in trade policy because their bound tariffs are above the applied tariffs, though the margins are generally quite narrow for the majority of them.
One way out would be to invoke, as a last resort, the General Agreement on Trade in Services balance-of-payments safeguard provisions, designed to address payment difficulties arising from a country’s efforts to expand its internal market or from instability in its terms of trade. If used judiciously, such measures would not necessarily restrict the overall volume of imports but rather their composition.
Selective restriction of non-essential, luxury imports as well as imports of goods and services for which domestic substitutes are available could ease payment constraints and facilitate expansionary macroeconomic policies by making it possible to increase imports of intermediate and capital goods needed for the expansion of domestic production and income.
The provision of adequate international liquidity by multilateral financial institutions could naturally alleviate the need for restrictive trade measures, even though it would not be wise for many developing economies, notably poor countries, to use such liquidity for importing non-essential goods and services. In the event of large and continued outflows of capital, countries should be prepared to impose exchange restrictions and even temporary debt standstills, and these should be supported by the International Monetary Fund (IMF) through lending into arrears.
China cannot introduce another massive investment package to maintain an acceptable pace of growth without compromising its future stability. An immediate increase in private consumption could be achieved through large transfers from the public sector, especially to the poor in rural areas, and sharply increased public provision of health and education. The former would raise the purchasing power of households while the latter would help reduce precautionary savings. China also needs to raise the share of wages in the gross domestic product (GDP) a lot faster than is promised by recent measures in order to shift to a consumption-led growth path.
For other developing and emerging economies, policy challenges vary, but they are all linked, one way or another, to accumulation and productivity growth. Commodity exporters in Latin America have little control over the two key determinants of their economic performance, namely capital flows and commodity prices, and their main policy challenge is how to break out of this dilemma and gain greater autonomy in growth.
They need to reduce dependence on foreign capital. Even though Latin America's wealthy receive a greater proportion of the national income than Asia's, they save and invest a much lower proportion of their income. Low levels of investment and productivity growth are the main reasons for Latin American deindustrialisation, somewhat aggravated by recent booms in commodity markets and capital flows.
As seen in South East Asia, a high rate of savings does not always translate into an equally high level of investment and, as seen in India, a high level of aggregate investment does not necessarily translate into rapid industrial growth. Overcoming all these difficulties requires targeted public interventions, including a judicious use of macroeconomic and industrial policy tools.