Adjusting to the

changing dynamics

of the world economy

U N I T E D N AT I O N S C O N F E R E N C E O N T R A D E A N D D E V E L O P M E N T

TRADE AND DEVELOPMENT REPORT, 2013

EMBARGOThe contents of this Report must not be

quoted or summarized in the print, broadcast or electronic media before

12 September 2013, 17:00 hours GMT

UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENTGENEVA

TRADE AND DEVELOPMENTREPORT, 2013

Report by the secretariat of theUnited Nations Conference on Trade and Development

UNITED NATIONSNew York and Geneva, 2013

• Symbols ofUnitedNations documents arecomposed of capital letters combinedwithfigures.MentionofsuchasymbolindicatesareferencetoaUnitedNationsdocument.

• ThedesignationsemployedandthepresentationofthematerialinthispublicationdonotimplytheexpressionofanyopinionwhatsoeveronthepartoftheSecretariatoftheUnitedNationsconcerning the legal status of any country,territory,cityorarea,orofitsauthorities,orconcerningthedelimitationofitsfrontiersorboundaries.

• Material in this publicationmay be freelyquoted or reprinted, but acknowledgementisrequested,togetherwithareferencetothedocumentnumber.AcopyofthepublicationcontainingthequotationorreprintshouldbesenttotheUNCTADsecretariat.

Note

UNCTAD/TDR/2013

UNiTeDNATioNSPUbliCATioN

Sales No.e.13.ii.D.3

iSbN978-92-1-112867-3eiSbN978-92-1-056284-3

iSSN0255-4607

Copyright©UnitedNations,2013Allrightsreserved

iii

Explanatory notes .......................................................................................................................................xi

Abbreviations ........................................................................................................................................... xiii

OVERVIEW ...................................................................................................................................... I–XVIII

Trade and Development Report, 2013

Contents

Page

Chapter I

Current trends and Challenges in the World eConomy......................................1

a. recent trends in the world economy...................................................................................................1 1. Globalgrowth....................................................................................................................................1 2. internationaltrade.............................................................................................................................4 3. Recenttrendsincommodityprices...................................................................................................8

B. the structural nature of the latest crisis...........................................................................................10 1. Animpossiblereturntothepre-crisisgrowthpattern..................................................................... 11 2. Rootsofthecrisis:thebuild-upofstructuralproblems..................................................................14

C. developing and transition economies are continuing to grow, but remain vulnerable................21 1. Growthperformancesincetheearly1990s.....................................................................................21 2. Vulnerabilitytotradeshocks...........................................................................................................25 3. Vulnerabilitytofinancialinstability................................................................................................29notes...........................................................................................................................................................32references..................................................................................................................................................35

Annex to chapter I

alternative scenarios for the World economy.......................................................................................37

iv

Page

Chapter II

toWards more BalanCed groWth: a greater role for domestiC demand in development strategies .................................................47

a. introduction.........................................................................................................................................47

B. global trade shocks and long-term trends: terms-of-trade and volume effects...........................49 1. Volumeandpricecomponentsofexternaltradeshocks..................................................................49 2. Recentmovementsinthetermsoftrade.........................................................................................50 3. Factorsaffectingcommodityprices:isasupercyclepeteringout?................................................52 4. Commodityprices:prospects..........................................................................................................59

C. volume effects on exporters of manufactures..................................................................................60

d. towards more domestic-demand-oriented growth strategies.........................................................62 1. Domestic-demand-orientedgrowthandbalanceofpayments........................................................63 2. Changesintheproductcompositionofdomesticdemand..............................................................67

e. policy implications..............................................................................................................................70 1. Policiestoboostdomesticdemand..................................................................................................72 2. Theroleofthepublicsectorinstrengtheningdomesticdemand....................................................80 3. Policiesforfosteringdomesticproductivitygrowthandstructuralchange....................................84 4. Conclusions.....................................................................................................................................87

notes...........................................................................................................................................................89

references..................................................................................................................................................91

Annex to chapter II

shifting growth strategies: main implications and Challenges..........................................................95

Chapter III

finanCing the real eConomy................................................................................................103

a. introduction.......................................................................................................................................103

B. Globaltrendsinfinanceandtheirimpactsondevelopingandtransitioneconomies................105 1. Trendsincross-bordercapitalmovementsandfinancialflowstodevelopingcountries..............105 2. Capitalflows,boomsandbustsinemergingmarketeconomies...................................................108

v

Page

C. the global crisis and the challenges ahead......................................................................................111 1. Thefinancialsituationandmonetarypoliciesindevelopedcountries...........................................111 2. impactsandpolicyresponsesindevelopingeconomies............................................................... 118

d. lessons and policy recommendations.............................................................................................125 1. Theroleandimpactoffinancialmarkets:areassessment.............................................................125 2. Counteringfinancialinstability....................................................................................................127 3. orientingthefinancialsectortowardsservingtherealeconomy..................................................132

e. summary and conclusions...............................................................................................................137

notes.........................................................................................................................................................138

references................................................................................................................................................140

vii

List of tables

Table Page

List of boxes

Box Page

2.1 Ashiftindevelopmentstrategies:lessonsfromthelatinAmericanexperienceafterthecrisisofthe1930s...........................................................................................................64

3.1 Capitalinflowsintoemergingmarketeconomies:someeconometricrelationships..................120

1.1 Worldoutputgrowth,2005–2013...................................................................................................2

1.2 exportandimportvolumesofgoods,selectedregionsandcountries,2009–2012.......................5

1.3 Worldprimarycommodityprices,2007–2013...............................................................................9

1.4 Short-termfiscalmultipliers.........................................................................................................13

1.5 Comparativeoutputgrowthperformance,selectedcountriesandcountrygroups,1991–2013..22

1.6 SharesinglobalGDP,selectedcountriesandcountrygroups,1970–2012.................................23

1.7 GDPbytypeofexpenditure,selectedcountriesandcountrygroups,1981–2011.......................24

1.8 Worldexportsbyoriginanddestination,selectedcountrygroups,1995–2012...........................27

1.9 South-Southexports,byregionandproductcategory,1995–2012..............................................28

1.A.1 Privateconsumption,privateinvestmentandemploymentgainsunderthetwoscenarios,byregion/group,Chinaandindia,2007–2030.............................................................................43

1.A.2 Publicspending,netpubliclendingandcurrentaccountbalanceunderthetwoscenarios,byregion/group,Chinaandindia,2007–2030.............................................................................44

2.1 Consumptionofselectedcommodities,byregionandeconomicgroup,2002–2012..................54

3.1 Netcapitalinflowsbyeconomicgroupandregion,1976–2011................................................107

3.2 Compositionofexternalfinancingtoemergingmarketeconomies,1979–2012.......................108

3.3 Sourcesofinvestmentfinance,selectedcountrygroups,2005–2012........................................133

viii

List of charts

Chart Page

1.1 Worldtradebyvolume,January2004–April2013........................................................................7

1.2 Monthlycommoditypriceindicesbycommoditygroup,Jan.2002–May2013.............................. 8

1.3 Changesintotalemploymentandemploymentratesindevelopedanddevelopingcountries,2008–2012.................................................................................................12

1.4 Shareofworldlabourincomeinworldgrossoutput,1980–2011...............................................14

1.5 Financialpositionsofpublicandprivatesectorsintheworldeconomy,1971–2011..................16

1.6 Contributionstoglobalimbalancesofselectedgroupsofcountries,1970–2011........................19

1.7 Tradeshocks,bydevelopingregionandexportspecialization,2004–2012................................26

1.8 evolutionofdeveloping-countryexportsbybroadproductcategory,1995–2012......................30

1.9 Pricetrendsinglobalassetmarkets,1980–2012..........................................................................31

1.A.1 GDPgrowth:historicalandestimatedunderthetwoscenarios,byregion/group,Chinaandindia,1995–2030.........................................................................................................40

1.A.2 labour-incomeshare:historicalandestimatedunderthetwoscenarios,byregion/group,Chinaandindia,1995–2030.............................................................................41

1.A.3 Globalimbalancesundertwoscenarios,1980–2030...................................................................45

2.1 Theglobaltradecollapseof2008–2009:mostaffectedeconomies,byexportspecialization....50

2.2 Trendsinthetermsoftrade,selectedprimarycommoditygroupsversusmanufactures,1865–2009.................................................................................................51

2.3 Netbartertermsoftrade,2000–2012...........................................................................................52

2.4 UnitedStatesimports,selectedconsumergoodscategories,1stquarter1999–4thquarter2012..................................................................................................61

2.5 UnitedStatesimportsofconsumergoods(excl.foodandautomobiles),bycategoryandselectedsourcecountries,1995–2012................................................................62

2.6 Percapitaincomeanddifferentincomeclasses,selectedcountries,2005...................................69

2.7 TypeofexpenditureasashareofGDP,selectedeconomies,2000–2011....................................71

2.8 Changesinwageshares,privateconsumptionandprivateinvestmentinselectedgroupsofcountriesfrom1991–1994to2004–2007..................................................74

2.9 HouseholddebtandhousepricesintheUnitedStates,1995–2012.............................................77

2.10 Householddebtandhouseprices,selecteddevelopingcountries,2000–2012............................78

3.1 Netcapitalinflowsbyeconomicgroup,1976–2011..................................................................106

3.2 Netprivatecapitalinflowstoemergingmarketeconomies,1978–2012...................................109

3.3 Privatesectorandgrosspublicdebt,selecteddevelopedcountries,1995–2012....................... 112

3.4 Netlending/borrowingbysector,UnitedStatesandeuroarea,2000–2012.............................. 113

ix

Chart Page

3.5 AssetcompositionoftheeuropeanCentralbankandtheUnitedStatesFederalReserve,2003–2013...................................................................................................... 114

3.6 Monetarybaseandbankclaimsontheprivatesector,2001–2012............................................ 115

3.7 Netcapitalinflowsandoutflows,2005–2012............................................................................ 117

3.8 europeanUnion:corecountries’commercialbankexposuretoperipherycountries,2001–2012................................................................................................. 118

3.9 Realeffectiveexchangerates(ReeR),selectedcountries,1990–2012.....................................122

3.10 bankclaimsontheprivatesector,selectedcountries,1990–2012............................................123

xi

Classification by country or commodity group

The classification of countries in thisReport has been adopted solely for the purposes of statistical oranalyticalconvenienceanddoesnotnecessarilyimplyanyjudgementconcerningthestageofdevelopmentofaparticularcountryorarea.Themajor country groupings used in thisReport follow the classification by theUnitedNationsStatisticaloffice(UNSo).Theyaredistinguishedas:

» Developedorindustrial(ized)countries:thecountriesmembersoftheoeCD(otherthanChile,Mexico,theRepublicofKoreaandTurkey)plusallothereUmembercountries.

» TransitioneconomiesreferstoSouth-easteurope,theCommonwealthofindependentStates(CiS)andGeorgia.

» Developingcountries:allcountries,territoriesorareasnotspecifiedabove.

Theterms“country”/“economy”refer,asappropriate,alsototerritoriesorareas.

References to “latinAmerica” in the text or tables include theCaribbean countries unless otherwiseindicated.

Referencesto“sub-SaharanAfrica”inthetextortablesincludeSouthAfricaunlessotherwiseindicated.

Forstatisticalpurposes,regionalgroupingsandclassificationsbycommoditygroupusedinthisReportfollowgenerallythoseemployedintheUNCTAD Handbook of Statistics 2012(UnitedNationspublication,salesno.b.12.ii.D.1)unlessotherwisestated.ThedataforChinadonotincludethoseforHongKongSpecialAdministrativeRegion(HongKongSAR),MacaoSpecialAdministrativeRegion(MacaoSAR)andTaiwanProvinceofChina.

Other notes

ReferencesinthetexttoTDRaretotheTrade and Development Report(ofaparticularyear).Forexample,TDR 2012referstoTrade and Development Report, 2012(UnitedNationspublication,salesno.e.12.ii.D.6).

Theterm“dollar”($)referstoUnitedStatesdollars,unlessotherwisestated.Theterm“billion”signifies1,000million.Theterm“tons”referstometrictons.Annualratesofgrowthandchangerefertocompoundrates.exportsarevaluedFobandimportsCiF,unlessotherwisespecified.Useofadash(–)betweendatesrepresentingyears,e.g.1988–1990,signifiesthefullperiodinvolved,includingtheinitialandfinalyears.Anobliquestroke(/)betweentwoyears,e.g.2000/01,signifiesafiscalorcropyear.Adot(.)indicatesthattheitemisnotapplicable.Twodots(..)indicatethatthedataarenotavailable,orarenotseparatelyreported.Adash(-)orazero(0)indicatesthattheamountisnilornegligible.Decimalsandpercentagesdonotnecessarilyadduptototalsbecauseofrounding.

Explanatory notes

xiii

Abbreviations

biS bankforinternationalSettlementsCiS CommonwealthofindependentStateseCb europeanCentralbankeClAC economicCommissionforlatinAmericaandtheCaribbeaneib europeaninvestmentbankeRM europeanexchangeRateMechanismeSCAP economicandSocialCommissionforAsiaandthePacificeU europeanUnionFAo FoodandAgricultureorganizationoftheUnitedNationsFDi foreigndirectinvestmentFSb FinancialStabilityboardGDP grossdomesticproductieA internationalenergyAgencyilo internationallabourorganization(oroffice)iMF internationalMonetaryFundlDC leastdevelopedcountryllR lenderoflastresortoDA officialdevelopmentassistanceoeCD organisationforeconomicCo-operationandDevelopmentoPeC organizationofthePetroleumexportingCountriesPPP purchasingpowerparityReeR realeffectiveexchangerateSMe smallandmedium-sizedenterpriseTDR TradeandDevelopmentReportTNC transnationalcorporationUNCTAD UnitedNationsConferenceonTradeandDevelopmentUN-DeSA UnitedNationsDepartmentofeconomicandSocialAffairsUNSD UnitedNationsStatisticsDivisionUSDA UnitedStatesDepartmentofAgricultureWTo WorldTradeorganization

OVERVIEw

Five years after the onset of the global financial crisis the world economy remains in a state of disarray. Strong expansionary monetary policies in the major developed economies have not succeeded in fostering credit creation and strengthening aggregate demand. Fiscal austerity and wage compression in many developed countries are further darkening the outlook, not only for the short term, but also for the medium term. The burden of adjustment of the global imbalances that contributed to the outbreak of the financial crisis remains with the deficit countries, thus strengthening deflationary forces in the world economy.

The dominance of finance over real economic activities persists, and may even have increased further. Yet financial reforms at the national level have been timid at best, advancing very slowly, if at all. In 2008 and 2009, policymakers of several economically powerful countries had called for urgent reforms of the international monetary and financial system. However, since then, the momentum in pushing for reform has all but disappeared from the international agenda. Consequently, the outlook for the world economy and for the global environment for development continues to be highly uncertain.

Some developing and transition economies have been able to mitigate the impact of the financial and economic crises in the developed countries by means of expansionary macroeconomic policies. But with the effects of such a response petering out and the external economic environment showing few signs of improvement, these economies are struggling to regain their growth momentum.

Prior to the Great Recession, exports from developing and transition economies grew rapidly owing to buoyant consumer demand in the developed countries, mainly the United States. This seemed to justify the adoption of an export-oriented growth model. But the expansion of the world economy, though favourable for many developing countries, was built on unsustainable global demand and financing patterns. Thus, reverting to pre-crisis growth strategies cannot be an option. Rather, in order to adjust to what now appears to be a structural shift in the world economy, many developing and transition economies are obliged to review their development strategies that have been overly dependent on exports for growth.

It is not a new insight that growth strategies that rely primarily on exports must sooner or later reach their limits when many countries pursue them simultaneously: competition among economies based on low unit labour costs and taxes leads to a race to the bottom, with few development gains but potentially disastrous social consequences. At the present juncture, where growth of demand from developed countries is expected to remain weak for a protracted period of time, the limitations of such a growth strategy are becoming even more obvious. Therefore, a rebalancing of the drivers of growth, with greater weight given to domestic demand, is indispensable. This will be a formidable challenge for all developing countries, though more difficult for some than for others. In any case, it will require a new perspective on the role of wages and the public sector in the development process. Distinct from export-led growth, development strategies that give a greater role than in the past to domestic demand for growth can be pursued by all countries simultaneously without beggar-thy-neighbour effects, and without counterproductive wage and tax competition. Moreover, if many trade partners in the developing world manage to expand their domestic demand simultaneously, they can spur South-South trade.

II

No sustained recovery of the world economy in sight

Theglobaleconomyisstillstrugglingtoreturntoastrongandsustainedgrowthpath.Therateofworldoutput,whichwas2.2percentin2012,isforecasttogrowatasimilarratein2013.Asinpreviousyears,developedcountriesareexpectedtoshowthepoorestperformance,witharound1percentincreaseingrossdomesticproduct(GDP).Developingandtransitioneconomiesarelikelytogrowbyalmost5percentand3percentrespectively.

economicactivityinmanydevelopedcountriesandanumberofemergingmarketeconomiesisstillsufferingfromtheimpactsofthefinancialandeconomiccrisisthatstartedin2008,andfromtheunsustainablefinancialprocessesanddomesticandinternationalimbalancesthatledtoit.However,continuingweakgrowthinseveralcountriesmayalsobepartlyduetotheircurrentmacroeconomicpolicystance.

intheeuropeanUnion(eU),GDPisexpectedtoshrinkforthesecondconsecutiveyear.economiccontractionislikelytobemoresevereintheeuroareathaninothereUcountries.Privatedemandremainssubdued,especiallyintheperipheryeconomies,duetohighunemployment,wagecompression,lowconsumerconfidenceandthestillincompleteprocessofbalancesheetconsolidation.Giventheongoingprocessofdeleveraging,expansionarymonetarypolicieshavefailedtoinducebankstoprovidemuch-needednewcredittotheprivatesectorthatcouldreinvigoratedemand.inthiscontext,theincreasedtendencytowardsfiscaltighteningmakesaquickreturntoahighergrowthtrajectoryhighlyunlikely.indeed,attemptstoresolvethecrisisintheeuroareathroughfiscalausteritymaybackfirebadly,asitaddsadeflationaryimpulsetoalreadyweakprivatedemand.Thecountriesintheeurozonethathavebeensufferingthemostfromthecrisiscontinuetooperateunderextremelyadverseconditions,whilegrowthinthesurpluscountrieshaslargelyreliedonstrongexports.Sincegovernmentsinthelattercountrieshavebeenreluctanttostimulatedomesticdemandbyothermeansthanmonetarypolicy,disequilibriumwithinthezonepersists.

Atthegloballevel,itisnotablethatJapanisbuckingthecurrentausteritytrendbyprovidingstrongfiscalstimulusandmonetaryexpansionthatareaimedatrevivingeconomicgrowthandcurbingdeflationarytrends.ThesemeasurescouldhelpmaintainitsGDPgrowthatcloseto2percentin2013.TheUnitedStatesisexpectedtogrowatasimilarrate,butbasedonadifferentsetoffactors.Partlyowingtosignificantprogressmadeintheconsolidationofitsbankingsector,privatedomesticdemandhasbeguntorecover.ontheotherhand,cutsinpublicspending,includingforneededinvestmentininfrastructure,arehavingacontractionaryeffect.Sincethenetoutcomeoftheseopposingtendenciesisunclear,thereisalsoconsiderableuncertaintyaboutwhethertheexpansionarymonetarypolicystancewillbemaintained.

Growth in many developing countries driven by domestic demand

Developingcountriesareexpectedtogrowbybetween4.5and5percentin2013,similarto2012.inmanyofthem,growthhasbeendrivenmorebydomesticdemandthanbyexports,asexternaldemandfromdevelopedeconomieshasremainedweak.inaddition,short-termcapitalinflows,attractedbyhigherinterestratesthaninthemajordevelopedcountries,havebeenexertingappreciationpressureonthecurrenciesofseveralemergingmarketeconomies,thusweakeningtheirexportsectors.

Asbefore,in2012outputgrowthwasstrongineast,SouthandSouth-eastAsia,at5.3percent,butrecentlytherehasbeenaslowdown,reflectingweakdemandfromsomeofthemajorexportmarkets.inChina,thecontributionofnetexportstoGDPgrowthdeclinedfurther,whilefixedinvestmentandprivateconsumption,asaresultoffasterwagegrowth,continuedtodriveoutputexpansion.Domesticdemand,encouragedbyvariousincomespolicymeasuresinanumberofothercountriesintheregion,suchasindia,indonesia,thePhilippinesandThailand,isalsosupportingoutputgrowth,whichmaythereforeacceleratemoderatelyintheregionasawholein2013.

III

economicgrowthinWestAsiasloweddowndramatically,from7.1percentin2011to3.2percentin2012,alevelthatisexpectedtobemaintainedin2013.Weakerexternaldemand,especiallyfromeurope,affectedtheentireregion,mostprominentlyTurkey,whosegrowthratedroppedsharplyfromaround9percentin2010and2011to2.2percentin2012.TheGulfCooperationCouncil(GCC)countriesmaintainedlargepublicspendingprogrammestosupportdomesticdemandandgrowth,despitescalingbacktheiroilproductionduringthelastquarterof2012tosupportoilprices.

GrowthinAfricaisexpectedtoslowdownin2013,owingtoweakerperformanceinNorthAfrica,wherepolitical instability insomecountrieshasbeenmirrored in recentyearsbystrongfluctuations ingrowth.insub-SaharanAfrica,bycontrast,GDPgrowthhasremainedstable,atabove5percent,owingtocontinuedhighearningsfromexportsofprimarycommoditiesandrelativelystrongpublicandprivateinvestmentinsomecountries.However,thetwolargesteconomiesoftheregion,NigeriaandSouthAfrica,faceconsiderabledownsiderisksduetofalteringexternaldemandandsomeweaknessesonthesupplyside.inaddition,severalleastdevelopedcountries(lDCs)oftheregionremainvulnerabletosuddenanddrasticswingsindemandforcertaincommodities.

GrowthisalsoexpectedtoremainrelativelystableinlatinAmericaandtheCaribbean,ataround3percent,onaverage,asaslowdowninsomecountries,includingMexico,islikelytobeoffsetbyfastergrowthinArgentinaandbrazil.overall,growthintheregionisbeingdrivenbydomesticdemand,basedonpublicandprivateconsumption.

Thetransitioneconomieshaveexperiencedadownwardtrendintheireconomicperformance.UndertheimpactofthecontinuingcrisisinmuchofWesterneurope,mostofthetransitioneconomiesofSouth-easterneuropeenteredintorecessionin2012.ThemembersoftheCommonwealthofindependentState(CiS)maintainedagrowthrateofover3percentin2012basedonsustaineddomesticdemand,butthisisexpectedtoslowdownslightlyin2013.TheeconomicoutlookfortheregionremainscloselylinkedtotheperformanceoftheeconomyoftheRussianFederationandtocommoditypricedevelopments.

Astherapidexpansionofdevelopingeconomiesasagrouphasfurtherincreasedtheirweightintheworldeconomy,anewpatternofglobalgrowthseemstobeemerging.Whiledevelopedcountriesremainthemainexportmarketsfordevelopingcountries,theshareofthelatter’scontributiontogrowthintheworldeconomyhasincreased,from28percentinthe1990stoabout40percentintheperiod2003–2007,andtocloseto75percentsince2008.However,morerecently,growthintheseeconomieshasdecelerated.ifdevelopingcountriescanincreasetheroleofdomesticdemandandSouth-Southtradeintheirdevelopmentstrategies,theymaycontinuetogrowatarelativelyfastpace,withincreasingpotentialtorelyoneachotherfortheexpansionofaggregatedemand.However,theycannotbeexpectedtoliftdevelopedcountriesoutoftheirsluggishgrowthpatternthroughhigherimportsfromthem.

Global trade expansion has virtually ground to a halt

internationaltradeingoodsandserviceshasnotreturnedtotherapidgrowthrateoftheyearsprecedingthecrisis.Afterasharpfallin2008–2009andaquickrecoveryin2010,thevolumeoftradeingoodsexpandedbyonly5percentin2011andbylessthan2percentin2012,anditaffecteddeveloped,developingandtransitioneconomiesalike.

Sluggisheconomicactivityindevelopedeconomiesaccountedformostoftheslowdownininternationaltrade.in2012,europeanimportsofgoodsshrankbyalmost3percentinvolumeandby5percentinvalue.extremelyweakintra-europeantradewasresponsibleforalmost90percentofthedeclineineuropeanexportsin2012.Japan’sexportshavenotyetrecoveredfromtheirsharpfallcausedbytheearthquakeof2011,whilethevolumeofitsimportshascontinuedtogrowatamoderatepace.Amongthemajordeveloped

IV

economies, only the United States maintained a positive growth rate in its international trade, although this appears to be slowing down in 2013.

Trade also decelerated considerably in developing and transition economies. Both exports and imports grew sluggishly in 2012 and the first months of 2013 in most developing regions. The sole exception was Africa, where exports recovered in countries previously affected by civil conflict. Export growth declined to 4 per cent in the developing countries as a whole. This slowdown included Asian countries that had previously played a major role in boosting international trade.

The rate of growth of China’s exports, by volume, declined from an average annual rate of 27 per cent during the period 2002–2007 to 13 per cent in 2011 and to 7 per cent in 2012, a lower rate than its GDP growth. Concomitantly, China’s imports, by volume, decelerated to 6 per cent in 2012 from 19 per cent, on average, between 2002 and 2007. Only regions exporting a large proportion of primary commodities (i.e. Africa, West Asia and, to a lesser extent, Latin America) saw a significant increase in their exports to China. Several exporters of manufactures in Asia registered a sizeable slowdown of growth in their external trade. This was the result not only of lower imports from Europe, but also of slower growth in some developing regions, in particular in East Asia.

The crisis of 2008–2009 has altered trade patterns in both developed and developing countries. Imports by all developed regions remain below their pre-crisis level, and only the United States has managed to increase its exports to a higher level than their previous peak of August 2008. On the other hand, exports from the group of emerging market economies were 22 per cent above their pre-crisis peaks, while the corresponding figure for their imports was 26 per cent higher. However, the pace of growth of trade of these economies has slowed down significantly: during the pre-crisis years, between 2002 and 2007, their export volume grew at an average annual rate of 11.3 per cent, but fell to only 3.5 per cent between January 2011 and April 2013. Growth in the volume of their imports also slowed down from 12.4 per cent to 5.5 per cent over the same period.

Overall, this general downward trend in international trade highlights the vulnerabilities developing countries continue to face at a time of lacklustre growth in developed countries. It is also indicative of a probably less favourable external trade environment over the next few years.

The particularities of a protracted downturn in developed countries

The difficulties of the developed countries as a group to find their way towards a path of sustained recovery following the recession of 2008–2009 suggests that the latest crisis is of quite a different nature than the cyclical crises of the past. From 2008 to 2012, global output growth averaged just 1.7 per cent. This is much slower than during any of the five-year periods that followed recessions in the global economy since the 1970s.

In this situation, expansionary policies would be needed to spur domestic demand and restore the confidence of households and firms. However, policymakers have instead been focusing their attention on restoring the confidence of financial markets. A central element of this strategy in developed countries has been fiscal austerity, based on the belief that high public debt ratios may eventually trigger a general aversion to sovereign debt, which could increase the risk premium and thereby impose a heavier debt burden on public finances. This strategy has not yielded the expected results. The outcome of fiscal contraction has negatively affected growth and job creation, as the expected increase in private demand has not materialized to compensate, or overcompensate, for the cuts in public spending. In addition, the fact that several countries that had strong trade relations with each other have been following austerity regimes at the same time has amplified their deflationary impact in the same way as simultaneous fiscal stimulus in 2009 generated very

V

positive results.Moreover,monetarypolicieshaveproved ineffective in thesense thatstrongmonetaryexpansionhasnottranslatedintoanincreaseinloanstotheprivatesector.Thisshowsthat,withouttheprospectofagrowth indemand, the increasingavailabilityofcredit isnotenough to stimulateprivateinvestmentandcreatejobs.

experiencehasshownthatanexpansionaryfiscalpolicycanhaveamuchstrongerimpactinsuchasituation,becausethisispreciselywhenithasaparticularlystrongmultipliereffect.Thelegitimateobjectiveofimprovingfiscalbalancesismorelikelytobeachievedthroughanexpansionofaggregatedemand,andthusthetaxbase,thanbyfiscalcontractionwhichreducesincomeandemploymentgrowth.inaddition,centralbankoperationsthatfocusonreducingtheriskofsovereigndebtandmaintaininglowinterestrateswouldenableareductioninpublicdebtservicing,andtherebylowermedium-tolong-termpublicdebtratiosthatareconsideredtoohigh.

Structural reforms are needed, but what kinds?

Despitemarkeddifferencesineconomicperformanceacrossregions,ingeneral,policiespursuedoverthepastthreeyearshavenotsucceededinresolvingthecrisis.Therecanbelittledoubtthat,inadditiontodemand-enhancingpolicies,structuralreformsareneededinmanycountriestoleadtheirnationaleconomiesandtheglobaleconomybacktoapathofsustainedgrowth.Severalproposalsforreformhavebeenmade,inparticularrelatingtothefinancialsector,thelabourmarket,publicfinancesandcentralbanking,butnotallofthemhaveadequatelyaddressedthecausesofthecrisis.

Amajorreasonforthecrisishasbeenthedominanceofthefinancialsectorovertherealsector.Financialliberalizationhas resulted ingovernmentsbeing increasingly influencedby thebelief that theyneed tomaintainorregainthe“confidence”offinancialmarkets.Thereformsadoptedsince2008,whichaimatimprovingsupervisionandcapitalizationofthebankingsystem,arehelpfulbutareunlikelytobesufficienttopreventactivitiesofthefinancialmarketsfromposingathreattoeconomicstability.Governmentsneedtocontrolfinancialmarketsmoreresolutelythaninthepastandlimitthepowerofthosemarketsovernational,regionalandglobaleconomies.

Formanyyearsprecedingthefinancialandeconomiccrisis,structuralreformwasvirtuallysynonymouswithintroducinggreaterflexibilityintothelabourmarket,especiallywageflexibility,andsuchreformisagainsuggestedasawayoutofthecrisis.butastrategyaimedatstrengtheningthecompetitivenessofeconomiesbyreducinglabourcostscompletelyneglectsthefactthatwagesareusuallyamajorsourceofdomesticdemand.Moreover,whensuchastrategyispursuedbymanycountriesatthesametime,itleadstoaracetothebottom,worsensincomedistributionandposesathreattosocialcohesion.Andgreaterinequalityofincomedistributionwasoneofthefactorsthatledtothecrisisinthefirstplace.instead,anincomespolicyaimedatacceleratingconsumptiongrowthcouldcontributedecisivelytorestoringnationaleconomies,andtheglobaleconomy,toastrongerbutalsomorebalancedgrowthpath.

Reformsaimedatfiscalconsolidationmaybenecessaryinmanycountries,buttheyneedtoconsidertheoverallmacroeconomiccontext.Publicfinancescannotbemanagedlikethefinancesofahouseholdbecausetheyinevitablyhaveanimpactontheentireeconomyandthespendingbehaviouroftheprivatesector.Attemptstoachievefiscalconsolidationintheshortrunhavebeenunsuccessfulatbest,andcounterproductiveandprocyclicalatworst.Suchconsolidationcanonlybeachievedafterseveralyearsofsustainedeconomicgrowth,andshouldnotbeconsideredaprerequisiteforeconomicrecovery.

Centralbanksofmanydevelopedcountrieshaverespondedtothefinancialcrisis,and,intheeurozone,tothecrisisinsomememberStates’publicfinances,withanumberofunorthodoxmeasures.buttheymayalsohavetofindnewwaysofmakingcreditavailabletonon-financialagentstouseinawaythatgeneratesdemand,incomeandemployment.

VI

Thesevariousnationalreformsalsorequiremoredeterminedinternationalcooperation,includinglongoverduereformoftheinternationalmonetarysystem,inordertoachievegreatersymmetryofadjustmenteffortsamongdeficitandsurpluseconomies.inthepresentsituation,severalcountrieswithlargecurrentaccountsurplusescouldprobablydomuchmoretohelprevivetheworldeconomy.

Developing and transition economies: better performance but continued vulnerability

oneofthemostsignificantchangesintheshapeoftheworldeconomyhasbeentheincreaseintheshareofdevelopingcountriesinglobalGDP.Theonsetoftheglobaleconomicandfinancialcrisisinitiallyreinforcedthistrend,asgrowthindevelopingcountriesin2008–2009deceleratedlessandrecoveredmorerapidlythanindevelopedcountries.Asaresult,theshareofdevelopedcountriesinglobalGDPdeclinedfrom79percentin1990toabout60percentin2012,whilethatofdevelopingcountriesmorethandoubled,from17percentto36percent,overthesameperiod.Mostofthischangeoccurredfrom2004onwards.

Nevertheless,economicdevelopmentsindevelopedcountriesremaincrucialforgrowthindevelopingcountries.indeed,thegrowthaccelerationinthelattersetofcountriesduringthe1990s,andespeciallyduringtheperiod2003–2007,wasassociatedwithalargerproportionofinternationaltradeinthecompositionoftheiraggregatedemand.Combinedwiththegenerallyfavourableexternaleconomicenvironment,suchasgrowingimportsbydevelopedcountries(especiallytheUnitedStates)andhistoricallyhighcommodityprices,particularlyduringthefiveyearspriortotheonsetofthecurrentcrisis,thegreateroutwardorientationofdevelopingcountriescontributedtotheirgrowth.

However,anexport-orientedgrowthstrategyalsoimpliesgreatervulnerabilitytoadeteriorationoftheexternalenvironment,ashasoccurredsince2008.Theinternationalpriceanddemandshocksduring2008–2009hadasevereimpactonbothexportersofprimarycommoditiesandexportersofmanufactures.Thesubsequentreboundwasmorerapidanditsbeneficialimpactgreateroncountrieswhoseexportscomprisealargeproportionofprimarycommoditiesthanforcountriesthatexportmainlymanufactures.

WeakerdemandfromdevelopedcountriessuggeststhatSouth-Southtrademayneedtoplayagreaterroleindevelopingcountries’growthstrategy.inthisrespect,itoffersgreaterpotentialthaninthepast,giventhattheshareofSouth-Southtradeintotalworldtradeincreasedfromslightlylessthan30percentin1995toslightlymorethan40percentin2012.Moreover,theshareofmanufacturesinadevelopingcountry’sexportstootherdevelopingcountriesandthevalueaddedinsuchtradeareusuallymuchhigherthantheyareinitsexportstodevelopedcountries,whichistestimonytothepotentialdevelopmentalroleofSouth-Southtrade.

Commodity price trends and outlook

UptothefinancialcrisisandtheGreatRecessionof2008–2009,rapidoutputgrowthinmanydevelopingandtransitioneconomieswastheresultoftheirstrongincreaseinexportsofmanufacturestodevelopedcountries.Thisinturncontributedtohigherexportearningsofotherdevelopingcountriesthatreliedonexportsofprimarycommodities.Sincetheturnofthemillennium,theselattercountrieshavealsobenefitedfromatrendchangeinthetermsoftrade.Thischangereflectednotonlyanupwardmovementinthemedium-termcommoditypricetrend,interruptedonlybrieflyin2008–2009,butalsoadeclineinworldpricesofcertainmanufactures,especiallylabour-intensivemanufactures.

Theincreasingdemandforcommoditiesinrapidlygrowingdevelopingcountries,notablyChina,andtheresultinghigherpricelevelsofmanyprimarycommodities,signifiesastructuralshiftinphysicalmarketfundamentals.Theupwardtrendinpriceshasalsobeensupportedbyaslowsupplyresponse,ashistoricallylowpricelevelsinthe1990shadledtoalongperiodofunderinvestmentinproductioncapacityforseveralkeycommodities,especiallyinthemineralandminingsectors.Atthesametime,theincreasingpresenceof

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financialinvestorsincommoditymarketshasaccentuatedtheproblemofpricevolatility.Projectionsaboutthefurtherevolutionofcommoditypricesareparticularlydifficultinthecurrentuncertainglobaleconomicenvironment,butthereislittledoubtthatthegrowthoutlookfordevelopingcountrieswillhaveasignificantimpactonfuturecommoditydemandtrends.

Continuingfastpopulationgrowthandrisingincomeindevelopingcountriesshouldleadtogreaterdemandforseveralfooditems.Moreover,asproductionisunlikelytoincreaseinlinewiththegrowingdemand,includingforbiofuels,agriculturalcommoditypricescouldremainhighoverthenextdecade.

Demandconditionsinthemarketsofmanyprimarycommoditiesthatareusedasinputsfortheproductionofmanufacturesandforconstructionaredeterminedbyanumberoffactors.onefactoriswhetherChinasucceedsinrebalancingitsgrowththroughanincreaseindomesticconsumption.Anotheriswhetherotherhighlypopulatedandrapidlygrowingdevelopingcountrieswillmovetoamorecommodity-intensivephaseofeconomicgrowthandindustrialization.evenifChina’sGDPgrowthslowsdown,resultinginaloweruseofsomecommodities, itsongoingindustrializationandpercapita incomegrowthcouldcontinuetohaveaconsiderableimpactonglobalmarkets,giventhesizeofitseconomy.if,inaddition,otherlargeandhighlypopulateddevelopingcountriesalsopursueapathofrapidindustrialization,thedemandprospectsforindustrialcommodities,particularlymetals,couldremainrobust.infrastructuredevelopmentassociatedwithrapidurbanizationalsooffersstrongpotentialtoincreasedemandforcommodities.

in addition, rising living standards inmany developing countriesmay boost demand for energycommoditiesinthemediumterm,despiteimprovementsinenergyefficiencythatcouldcontributetoadeclineinenergyuseperunitofGDP.oilpricescouldremainhistoricallyhigh,eveniftheyfallslightlycomparedwiththeir2011–2012levels,asdemandfromsomeoftherapidlygrowingdevelopingcountrieswillcontinuetoriseandbecausetheexploitationcostsofnewsuppliesarehigherthanthosefromconventionalsources.

overall,commoditypricesmaynotriseasfastastheyhaveoverthepastdecade,but,followingsomedownwardadjustmentsintheshortterm,theyshouldstabilizeatarelativelyhighlevelincomparisonwiththeearly2000s.However,thisshouldnotleadtocomplacencyinthedesignofdevelopmentstrategiesinnatural-resource-richcountries.Theirmainchallengeremainsthatofappropriatingafairshareoftheresourcerentsandchannellingrevenuestowardsinvestmentintherealeconomyinordertospurthediversificationandupgradingofproductionandexports.

Export-led growth strategies are reaching their limits

Akeyproblemforpolicymakersinthedevelopingandtransitioneconomiesthathavealargeshareofmanufacturesintheirexportsisthatgrowthofexportsandincomesintheircountriesislikelytobeadverselyaffectedbycontinuedslowgrowthindevelopedcountries’finalexpenditureforseveralyearstocome.inanumberofthesecountries,productionofmanufacturedgoodsfortheworldmarkethasdriventheexpansionoftheirformalmodernsectors,butinmostofthemdomesticdemandhasnotincreasedapace.Thishasbeenpartlyduetoweaklinkagesbetweentheexportsectorandtherestoftheeconomy,andpartlytothestrategyoftheirfirmsandgovernmentstostrengthentheinternationalcompetitivenessoftheirdomesticproducersbykeepingwageslow.Suchastrategywilleventuallyreachitslimit,aslowwagesdampendomesticdemandgrowth,especiallywhenmanyothercountriespursuethesamestrategysimultaneously.Sincethegrowthofdemandindevelopedcountriesislikelytoremainweakforanextendedperiodoftime,thelimitationsof sucha strategybecomeevenmoreacute. in thesecircumstances,continuingwithexport-ledgrowthstrategiesthroughwageandtaxcompetitionwouldexacerbatetheharmcausedbyslowergrowthinexportmarketsandreduceanyoverallbenefits.

Theadoptionofcountercyclicalmacroeconomicpoliciescancompensateforresultinggrowthshortfallsforsometime.indeed,mostdevelopingcountriesreactedtothedeclineintheirnetexportsbyincreasingtheshareofgovernmentexpenditureinGDP.Therewasalsoanincreaseofprivateconsumptionasashare

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ofGDPinsomeofthesecountries,andofgrossfixedcapitalformationasashareofGDPinsomeothers.However,beyondsuchshort-termresponses,developingcountriesmayneedtotakeamorecomprehensiveandlongertermperspective,involvingashiftindevelopmentstrategiesthatgivesgreaterweighttodomesticdemandasanengineofgrowth.Suchamovetowardsamorebalancedgrowthpathcouldcompensatefortheadverseimpactofslowergrowingexportstodevelopedcountries.Moreover,thismorebalancedgrowthstrategycouldbepursuedbyalldevelopingcountriessimultaneouslywithoutbeggar-thy-neighboureffects.However,therearemanychallengesinvolvedinmovingtowardsamorebalancedgrowthstrategy.Theseincludeboostingdomesticpurchasingpower,managingdomesticdemandexpansioninawaythatavoidsanexcessiveincreaseinimportdemand,andnurturingtheinterrelationshipbetweenhouseholdandgovernmentexpenditure,ontheonehand,andinvestmentontheother,toenablethesectoralcompositionofdomesticproductiontoadjusttonewdemandpatterns,includingthroughincreasedregionalandSouth-Southtrade.

Hence,shiftingthefocusofdevelopmentstrategiestodomesticmarketsdoesnotmeanminimizingtheimportanceoftheroleofexports.indeed,exportscouldexpandfurtherifseveraltradepartnersweretoachievehighereconomicgrowthatthesametime.

Rebalancing domestic and external forces of growth

inseekinggreaterintegrationintoarapidlyglobalizingeconomy,thecriticalimportanceofdomesticdemandasamajorimpetusforindustrializationisoftenoverlooked.Growthofdomesticdemandaccountsforaboutthreequartersoftheincreaseindomesticindustrialoutputinlargeeconomies,andslightlymorethanhalfinsmalleconomies.Acceleratingdomesticdemandgrowthcouldthereforebehighlybeneficialforoutputgrowthandindustrialization,particularlyinacontextofweakeningexternaldemandgrowth.Thepossibilityofchangingrapidlytowardsamoredomestic-demand-orientedgrowthstrategywilldependlargelyonhowcloselythesectoralstructureofdomesticproductionislinkedtothepatternofdomesticdemand.Thislinkagewillbeparticularlyweakincountriesthatexportalargeproportionofprimarycommodities.itthereforeremainsveryimportantforthesecountriestousetheirresource-relatedrevenuestodiversifytheirsectoralstructureofproductionbyincreasingthesharesofmanufacturesandmodernservices,bothpublicandprivate.bydeveloping the linkagesbetween theexportingsectorsand the restof theeconomy, thisdiversificationwouldgeneratenewemploymentandincomeopportunities,andstrengthenthedomesticmarket.

Astrategythatplacesgreateremphasisondomesticdemandwillneedtoaimatanappropriatebalancebetweenincreasesinhouseholdconsumption,privateinvestmentandpublicexpenditure.Thereisastronginterrelationshipbetweenthesethreecomponentsofdomesticdemand.increasedconsumptionofgoodsandservicesthatcanbeproduceddomesticallymakesproducersofthosegoodsandservicesmorewillingtoinvestintheirproductivecapacity.Higherinvestmentisnotonlyitselfasourceofdomesticdemand(evenifalargeshareofthecapitalgoodsmayhavetobeimported),butitisalsoapreconditionforthecreationofemploymentandforproductivitygainsthatallowwagestogrowalongwiththepurchasingpowerofdomesticconsumers.Moreover,higherincomesofhouseholdsandfirmsraisetaxrevenues,whichcanthenbespentbythegovernmentforenhancingpublicservicesandinfrastructuredevelopment,evenatunchangedtaxrates.Higherpublicspending,inturn,cancreateadditionalincomeforhouseholdsandfirms,andimprovethe conditions for private investment.Such investment is indispensable for increasingdomestic supplycapacity,andthusforreducingleakagesofdomesticdemandgrowththroughimports.

Increasing domestic consumption

labourincomeisthemostimportantsourceofhouseholdconsumption,whichgenerallyaccountsforbetweenhalfandthreequartersofaggregatedemand,eveninrelativelypoorcountriesandcountrieswitharelativelylargeexportsector.Thusfosteringthepurchasingpowerofthepopulationingeneral,andofwageearnersinparticular,shouldbethemainingredientofadomestic-demand-drivengrowthstrategy.

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Whileexport-ledstrategiesfocusonthecostaspectofwages,adomestic-demand-orientedstrategywouldfocusprimarilyontheincomeaspectofwages,asitisbasedonhouseholdspendingasthelargestcomponentofeffectivedemand.ifwagegrowthfollowsthepathofproductivitygrowth,itwillcreateasufficientamountofdomesticdemandtofullyemploythegrowingproductivecapacitiesoftheeconomywithouthavingtorelyoncontinuedexportgrowth.

ineconomieswith fairly large formalsectors, the functioningofsuchan incomespolicycouldbeenhancedbybuildinginstitutionsforcollectivebargainingandtheintroductionoflegalminimumwages.incountrieswhereinformalemploymentandself-employmentarewidespread,targetedsocialtransfersandpublicsectoremploymentschemescanplayanimportantcomplementaryrole.incountrieswithalargeruralsectorwithmanysmallproducers,introducingmechanismsthatensurefairpricesforagriculturalproducers–forinstancebylinkingthosepricestotheoverallproductivitygrowthoftheeconomy–wouldbeanotherelementofastrategytoincreasedomesticconsumption,strengthensocialcohesionandatthesametimeinducemoreproductivity-enhancinginvestments.Moreover,thelayersofthepopulationthatwillprimarilybenefitfromsuchanincomespolicywouldbelikelytospendmostoftheirincomeonlocallyproducedgoodsandservices.inaddition,governmentscantakediscretionaryfiscalactions,suchasprovidingtaxrebatesoncertainconsumergoodsthatare,orcanbe,produceddomestically.

Spurringdomesticdemandby facilitatingaccess toconsumercredit for theacquisitionofdurableconsumergoodstendstoberisky,asamplydemonstratedbyrecentexperiencesinanumberofdevelopedcountries.Thedebtservicingburdenofhouseholdsmayrapidlybecomeexcessive if interest rates rise,growthofhouseholdincomesstallsorthepricesofassetsusedascollateralfall.

Increasing domestic investment

Domesticinvestment,bothprivateandpublic,playsacrucialroleinanygrowthstrategy,regardlessofwhetheritisorientedtowardsexportsordomesticdemand.Theexpectationthatfuturedemandwillbehighenoughtofullyutilizeadditionalproductivecapacityisthemainincentiveforentrepreneurstoinvestinexpandingthatcapacity.Sinceexportsareunlikelytogrowatthesamepaceasinthepast,giventhecurrentstateoftheworldeconomy,domesticdemandgrowthwillbecomemoreimportantinformingthedemandexpectationsofpotentialinvestors.Akeydeterminantoftheirabilitytostrengthenproductivecapacityistheavailabilityoflong-termfinanceatanaffordablecostandacompetitiveexchangerate.Thisinturndepends,toalargeextent,oncentralbankpolicyandthestructureandfunctioningofthedomesticfinancialsystem.

Direct and indirect demand effects of public expenditure

Thepossibilityofstrengtheningdomesticdemandbyincreasingpublicsectorspendingdependsontheinitialconditionsofthepublicfinancesineachcountry,butalsoontheeffectsofincreasedpublicexpenditureonpublicrevenue.Publicspendingandtaxationarepotentiallykeyinstrumentsforshapingthedistributionofpurchasingpowerinaneconomy.beyonditsdirecteffectsonaggregatedemand,publicinvestmentininfrastructureand/orpublicservicestospecificindustrialclustersareoftenapreconditionfortheviabilityofprivateinvestment,forenhancingtheproductivityofprivatecapital,andforcomplementingthemarketmechanismbyfacilitatingthecreationoflinkagesbetweenexportindustriesandtherestoftheeconomy.inaddition,publicexpenditureoneducationandtrainingcaninfluencethepotentialoflabourtocontributetoproductivitygrowth.Moreover,countercyclicalfiscalpolicycanstabilizedomesticdemandduringperiodsofslowgrowthorrecession,andthuspreventaloweringofthedemandexpectationsofdomesticinvestors.Thisstabilizationpotentialwillbegreater,thelargertheshareofthepublicsectorinGDP.

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incomeredistributionthroughthetaxationstructureandtransfers tohouseholdscanstrengthenthepurchasingpowerofthoseincomegroupsthatspendalargershareoftheirincomeonconsumptioningeneral,andondomesticallyproducedgoodsandservices,inparticular,thanhigherincomegroups.

Raising public revenues

The“fiscalspace”forstrengtheningdomesticdemand,directlyorindirectly,throughincreasedpublicspendingindevelopingcountries,especiallyinlow-incomeandleastdevelopedcountries,tendstobemorelimitedthanindevelopedcountries.Thisisnotonlybecausetheirtaxbaseissmaller,butalsotheircapacitytoadministerandenforcetaxlegislationisoftenweak.Moreover,inmanyofthesecountriespublicfinancesarestronglyinfluencedbyfactorsthatarebeyondthecontroloftheirgovernments,suchasfluctuationsincommoditypricesandininterestratesontheirexternaldebt.buttoalargeextentfiscalspaceisalsodeterminedendogenously,sincespendingofpublicrevenuecreatesincome,andthusadditionalspendingintheprivatesector,therebyenlargingthetaxbase.Theseincomeeffectsvary,dependingonhowthetaxburdenisdistributedandpublicrevenueisspent.Takingaccountofsuchcompositionaleffectsofboththerevenueandtheexpendituresideimpliesthatthescopeforusingtaxationandgovernmentspendingforstrengtheningdomesticforcesofgrowthmaybegreaterthanisoftenassumed.

inmanydevelopingandtransitioneconomies,thereappearstobescopeformoreprogressivetaxationandfortaxingwealthandinheritance,aswellasforraisingadditionalrevenuebyimposinghighertaxesonmultinationalcorporations.Thelatterwouldrequirethatdevelopingcountries,intheireffortstoattractforeigndirectinvestment(FDi),avoidengagingintaxcompetitionwitheachother.Suchcompetition,likeinternationalwagecompetition,isattheexpenseofallthecountriesconcerned.Theseconsiderationsareofparticularrelevanceforcountriesthatarerichinmineralresources,whereoftenonlyaverysmallshareoftheresourcerentsremainsintherespectivecountriesintheformofprivateincomeorpublicrevenue.

inseverallow-incomeandleastdevelopedcountriesmultilateralfinancialinstitutionsandbilateraldonorswouldneedtohelpbyprovidingadditionalresourcesforsocialspending,aswellassupportforimprovingtheadministrativecapacitiesneededtostrengthentheroleofpublicfinancesindevelopmentstrategies.

The rationale for debt-financed public spending

Rebalancingdomesticandexternal forcesofgrowthmayalsorequireadifferentapproach todebtfinancingofpublicexpenditure.itcanbeastrategicinstrumentnotonlyinthecontextofacountercyclicalfiscalpolicy,butalsoforstretchingthefiscalburdenoflargepublicinfrastructureprojects.Suchprojectstypicallyhelptoincreasetheproductivityoftheeconomyatlargeandgeneratebenefitsforhouseholdsandfirmsinthefuture,bywhichtimeeconomicgrowthwouldhelpservicetheinitiallyincurreddebt.

Whileitmaybepreferableforgovernmentstopayallpublicexpenditureoutofcurrentrevenue,arationalapproachinafast-growingdevelopingeconomycouldalsobebasedontheprinciplethatcurrentexpenditure, including social expenditure, should befinanced by taxation and other current revenues,whereaspublicinvestmentmaybefinancedbyborrowing,sincesuchinvestmenthasapay-offintheformofadditionaltaxreceiptsfromanenlargedtaxbaseinthefuture.Governmentsshouldconsiderborrowinginforeigncurrencyonlytotheextentthatpublicinvestmentsorgovernmentsupporttoprivateinvestmentsrequireimportingcapitalgoods,materialsandknow-how.Wherethereisasufficientpossibilityforpublicsectorborrowingforthesepurposes,anincreaseincredit-financedpublicexpendituremaybeconsideredawaytoboostnotonlydomesticdemandbutalsodomesticsupplycapacities.

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Changing composition of consumption with rising personal incomes

Consumptionpatternsarechangingwithrisingincomelevels.oncetheincomeofindividualconsumerscrossesacertainthreshold,theywilluseasmallershareofthatincomeforsatisfyingtheirbasicorsubsistenceneeds.Thethresholdswhichtriggeranaccelerationofdemandforotherconsumptionitemstypicallyclusteratalevelofpercapitaincomeatwhichanindividualisconsideredtoenterthe“middleclass”(i.e.thosesegmentsofthepopulationinanysocietythathaveacertainamountofdiscretionaryincomeattheirdisposal,whichallowsthemtoengageinconsumptionpatternsbeyondjustthesatisfactionoftheirbasicneeds).Thefutureevolutionofconsumptionpatternsthereforedependsonthenumberofpeoplethatareataroundtheentrylevelofthemiddleclass,wherethenewspendingpatternsstartemerging.

basedonanumberofprojections,ithasbeenestimatedthattheproportionofthemiddleclassinthetotalworldpopulationwillincreasefrom26percentin2009to41percentin2020and58percentin2030,andthatthisproportionwillgrowmorethanfourfoldindevelopingcountries.Asiawillaccountforthebulkofthisincrease,withthenumberofpeoplebelongingtothemiddleclassinthisregionestimatedtogrowsixfold;inCentralandSouthAmericathenumberisexpectedtogrowbyafactorof2.5,andinsub-SaharanAfricaitshouldtriple.Astrategythatgivesgreateremphasistodomestic-demand-drivengrowth,ifsuccessful,mightwellacceleratethesetrends,asitwouldbeassociatedwithfasterwageincreasesandamoreequalincomedistributionthaninthepast.Therefore,manydevelopingandtransitioneconomiescouldachievearapidaccelerationofconsumptionofdurableconsumergoodsinthemediumterm.

Anenlargedmiddleclassmaybethemostimportantsourceofbuyingpowerfordomesticmanufacturers,becauseitwilleventuallydeterminetheextentofhorizontalcomplementaritiesacrossallindustriesoftheeconomy.And to theextent that thepurchasingpowerof incomegroupsbelowthe levelof themiddleclassalsogrows,theremaybeadditionalproductivitygainsinsectorsandfirmsthatproduceprimarilyforthedomesticmarket,asthelowerincomegroupstendtospendtheirincomesonagreatershareoflocallyproducedorproduciblegoodsandservices.

Domestic demand growth and its implications for the development of productive capacities

The import intensity of the three components of domestic demand (i.e. household consumption,governmentexpenditureandinvestment)varieswidely.importstendtobestronglycorrelated,onaverage,withinvestmentandproductionforexport,butlesswithconsumption(especiallyconsumptionbyhouseholdsinthelowerincomebrackets)andpublicexpenditure.Still,ifdomesticproductivecapacityisnotupgradedinaccordancewiththechangingpatternofdemandinagrowingeconomy,theincreaseindomesticconsumptionexpenditurewilltendtoinducehigherimports.inordertopreventadeteriorationinthetradebalanceasaresultofbothfastergrowthandthechangingcompositionofdomesticdemandgrowth,coupledwithlowerexportgrowth,itwillbeessentialtostrengthendomesticinvestmentandinnovationdynamicstobringaboutappropriatechangesinthesectoralcompositionofdomesticproduction.

effortstoorientdomesticproductiontorespondtothechanginglevelandcompositionofdomesticdemandwilltendtobeeasierforthosecountrieswhichinthepasthavereliedsignificantlyonexportsofmanufactures to developed countries, because they canbuild on their considerable existingproductivecapacityandexperienceinmanufacturingactivities.However,itwillbemoredifficultiftheseactivitieshavebeengearedmainlytotheproductionofsophisticatedgoodsforaffluentconsumersindevelopedcountries,whichfewdomesticconsumerscanafford.Arapidshiftfromanexport-drivengrowthstrategytoonethatgivesgreateremphasistoanexpansionofdomesticdemandtodrivegrowthwillbeevenmoredifficultincountriesthathavebeenrelyingontheproductionandexportofprimarycommodities.

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ontheotherhand,whiledevelopingcountriesshouldstillseektodeveloporadaptnewtechnologiesaccordingtotheirspecificneeds,anadvantageforproducersindevelopingandtransitioneconomiesthatfocusmoreondomesticthanonglobalmarketsisthattechnologicallaggingtendstobelessofaconstrainingfactor.

Advantages of proximity to markets and regional integration

Anotheradvantageforproducersindevelopingcountriesistheirproximitytotheirdomesticmarketand,where applicable, their regionalmarket.Changes inmarket conditions arising from the expansionandchangingcompositionofdomesticdemandnecessitatetheidentificationof“latentdemand”andthe“steering”offirmstomeetrequirementsspecifictothosenewmarkets.inthisregard,thelocalknowledgeofdomesticfirmsforthedevelopmentofappropriatenewproducts,distributionnetworksandmarketingstrategiesmaybecomeavaluableassetincompetingwithforeignsuppliersofsimilargoods.inaddition,totheextentthatdevelopingandtransitioneconomiesassumeagreaterweightinglobalconsumptiongrowth,theresultingchangesinthepatternofglobaldemandarelikelytoinfluencemarketopportunitiesforalltheseeconomiesinareasofproductionthataremorealignedthaninthepasttothepatternsofdemandprevailingindevelopingcountries.Thisinturnwillleadtochangesinthesectoralallocationofinvestmentsinawaythatbettercorrespondstothepatternofdomesticdemandinthosecountries.

Moreover, ifmany tradepartners in thedevelopingworldwere to expand their domestic demandsimultaneously,theycouldbecomemarketsforeachother’sgoodsandservices.Theresultingincreaseinexportswouldhelpreducethebalance-of-paymentsconstraintsthatarisefromaslowdownofexportstodevelopedcountries.Consequently,strengthenedregionalintegrationand,moregenerally,intensifiedeffortstostrengthenSouth-Southtrade,maybeimportantcomplementstodomestic-demand-ledgrowthstrategies.

Industrial policies in support of investment and structural change

experienceindevelopedanddevelopingcountrieshasshownthatgovernments,inadditiontomarketforces,canplayanimportantroleinsupportofindustrialization.inthepast,industrialpolicieshaveoftenfocusedonstrengtheningexportcapacitiesandestablishinganexport-investmentnexus.However,achangeintherespectiveweightsofforeignanddomesticdemandmayrequireanadaptationofindustrialpolicy,withagreateremphasisonstrengtheningthecompetitivenessofdomesticproducersindomesticmarketsandgearingproductionstructurestothechangingcompositionofdomesticdemandaspercapitaincomegrows.SuchadaptationmayneedtofullyutilizethepolicyspacestillavailabletothesecountriesfollowingtheUruguayRoundtradeagreementsandvariousregionalandbilateraltradeandinvestmentagreements.Furthermore,someoftheseagreementsmayneedtoberevisedtotakebetteraccountoftheinterestsofdevelopingcountries,forexamplebyallowingthemagreaterdegreeoftemporaryprotectionofcertainindustriesthatareatanearlystageofdevelopment.

Capitalformationthatrespondstochangingdemandpatternsmaybesupportedbyhelpingprivatefirmstoidentifytheproductgroupsthatshowthegreatestdynamismasanincreasingshareofthepopulationentersthemiddleclass.Publicsupportmeasuresmayalsofacilitatecoordinationofproductionalongthevalue-addedchain,includingfiscalandfinancialsupportfornewproductionactivitiesthatareconsideredstrategicallyimportantfordomesticproductionnetworks.Aproactiveindustrialpolicymaybeespeciallyimportant−andhavethegreatestimpact−ineconomiesthatarestilldependentonnaturalresourcesandwherethereisanurgentneedfordiversificationofproduction.

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Challenges for financial policies in developing countries

Theadjustmentofproductivecapacitiestochangesinthecompositionofaggregatedemandindevelopingandtransitioneconomiesrequiresreliableandlow-costaccessoftheirproducerstofinancialresourcesforproductiveinvestment.inthecurrentglobalcontext,althoughthereisampleliquidityinthebankingsystemsofthemajordevelopedcountries,uncertaintyinfinancialmarketsisparticularlyhigh.Thisincreasestheriskofemergingmarketsbeingaffectedbydisturbancesemanatingfromthebehaviourofinternationalcapitalmarkets,sinceavolatileinternationalfinancialenvironment,fragilenationalbankingsystemsandweakdomesticfinancialinstitutionshaveoftenhinderedinvestmentinmanycountries.

Thispresentsanumberofchallengesforfinancialpolicyindevelopingandtransitioneconomies:first,theyneedtoprotecttheirnationalfinancialsystemsagainstthevagariesofinternationalfinance;second,policymakersshoulddraw the right lessons frompastfinancialcrises, inparticular, thatanunregulatedfinancialsectortendstogenerateeconomicinstabilityandresourcemisallocation;andthird,theyshouldaimtomaketheirdomesticfinancialsystems,especiallytheirbankingsystems,moresupportiveofinvestmentinrealproductivecapacity.

Atypical behaviour of international capital flows since 2008

overthepastthreedecadesemergingmarketeconomiesexperiencedfrequentwavesofinternationalcapitalflows.Suchwavestypicallystartedwhengrowthwasslow,liquiditywasabundantandinterestrateswerelowinthedevelopedcountries.Thismadeemergingmarketsseemattractivedestinationsforprivateinternationalcapitalflows.However,thosewavesebbedwheninterestratesroseinthedevelopedcountriesorwhenfinancialmarketparticipantsdeemedexternaldeficitsortheforeignindebtednessofthedestinationcountriestohavebecomeunsustainable.

Atpresent,monetaryandfinancialconditionsinmajordevelopedcountriesresemblethosethatinthepastprovedtobeconducivetosurgesofcapitalflowstoemergingmarketeconomies.indevelopedcountries,interestrateshavefallentoalmostzeroinanefforttotackleboththeprotractedcrisisandthedifficultiesintheirfinancialsectors.Theircentralbankshavealsoinjectedlargeamountsofliquidityintothefinancialsystem.However, thesemeasureshavenotsucceededininducingbankstoincreasetheir lendingtotheprivatesector.Moreover,therearefairlylargeinterestratedifferentialsinfavourofemergingmarkets.Sofar,theseconditionshavenotresultedinstrongandsustainedcapitaloutflowsfromdevelopedtodevelopingcountries;rather,wheresuchoutflowshaveoccurred,theyhavebeenveryvolatile.

Priortotheeruptionofthefinancialcrisis,therewerelargecapitalflowsfromdevelopedcountriestoemergingmarketeconomies,whichendedabruptlyin2008.but,distinctfrompastepisodes,this“suddenstop”wasnottriggeredeitherbyanincreaseininterestratesinthedevelopedcountries,orbyexcessivecurrentaccountdeficitsordebtservicingproblemsintheemergingmarketeconomies.Rather,theyappeartohavebeenmotivatedbyuncertaintyaboutthepossiblerepercussionsofthefinancialcrisisonthelattereconomies,andattemptsbyinternationalinvestorstominimizetheiroverallriskexposure.Whenprivatecapitalflowstoemergingmarketeconomiessurgedagainin2010and2011,thistoowasatypical,becausesuddenstopsareusuallyfollowedbyaprolongedperiodofstagnationofinflowsorevenoutflowsfromthesecountries.Facedwith lowprofit-makingopportunities in themajorfinancial centres, itmayhavebeenexpectedthatinvestorswouldbeencouragedbytherapidresumptionofGDPgrowthintheemergingmarketeconomiesandtheperceptionthattheirfinancialsystemsweremorestablethanthoseofdevelopedcountries.However,newlyworseningprospectsindevelopedcountriesinthesecondhalfof2011,includinghigherperceivedrisksrelatedtothesovereigndebtofsomeofthem,againcurtailedcapitalflowstowardstheemergingmarketeconomiesasinvestorssoughttoreducetheiroverallportfoliorisks.

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The vagaries of international finance remain a threat

emergingmarketeconomieshavebeenrelativelyresilientinthefaceofthedestabilizingeffectsofthelatestwavesofcapitalflowsontheirnationalfinancialsystems.Thisobservationdoesnotmean,however,thattheyhavebecomestructurallylessvulnerable.Rather,itshowsthemeritsoftheirpolicyreorientationwithrespecttoexternalfinancesincetheturnofthemillennium.Anincreasingnumberofdeveloping-countrygovernmentshaveadoptedamorecautiousattitudetowardslargecapitalinflows.Someofthemwereabletopreventoratleastmitigatecurrencyappreciationthroughinterventionintheforeignexchangemarket,alongwithassociatedreserveaccumulation.othersalsoresortedtocapitalcontrols.Anotherfactorexplaininghowseveralofthemwereabletocopewiththeadversefinancialeventswastheirlowerlevelsofexternaldebtanditsmorefavourablecurrencycompositioncomparedwithearlierepisodes.

However,sinceglobalfinancialassetsamounttomorethanthreetimesthevalueofglobaloutput,evenminorportfolioadjustmentsorientedtowardsdevelopingcountriescanleadtoanincreaseinsuchflowsataratethathasthepotentialtodestabilizetheeconomiesofthesecountriesinthefuture.inthecurrentsituationofhighuncertainty,investorsentiment,ratherthanmacroeconomicfundamentals,istendingtodrivecapitalmovements,ashasfrequentlybeenthecaseinthepast.butthereisalsouncertaintywithregardtothefundamentals.ontheonehand,anextendedperiodoflowinterestratesinthedevelopedcountries,combinedwithstrongergrowthandatendencytowardshigherinterestratesinemergingmarketeconomiescouldleadtoanewsurgeofcapitalflowstothelatter.ontheotherhand,atighteningofmonetarypolicyinthemajorreservecurrencycountriescouldcauseadrasticreductionorreversalofnetprivatecapitalflowsfromthem.

Reducing exposure to international financial markets

As longas the internationalcommunity fails toagreeon fundamental reformsof the internationalfinancialandmonetarysystem,developingandtransitioneconomiesneedtodesignnationalstrategiesand,wherepossible,regionalstrategies,aimedatreducingtheirvulnerabilitytoglobalfinancialshocks.inthecurrentsituation,thismeansthattheseeconomiesneedtoexerciseextremecautiontowardscross-bordercapitalflows,bearinginmindthattheseedsofafuturecrisisaresowninthephaseofeuphoria,whenawaveoffinancialinflowsisinthemaking.

Formanyyears,theprevalentviewconsideredalmostanykindofforeigncapitalflowstodevelopingcountriesasbeneficial.Thisviewwasbasedontheassumptionthat“foreignsavings”wouldcomplementthenationalsavingsoftherecipientcountriesandleadtohigherratesofinvestmentthere.However,boththeoreticalconsiderationsandempiricalevidenceshowthatevenhugecapitalinflowscanbeaccompaniedbystagnatinginvestmentrates,becausethelinkbetweencapital inflowsandthefinancingofnewfixedinvestmenttendstobeveryweak.Forthesamereason,substantialincreasesinfixedinvestmentcanbeaccompaniedbystrongcapitaloutflows.

externalfinancing of developing and transition economies has repeatedly proved to be a double-edgedsword.ontheonehand,itcanbeawayofalleviatingbalance-of-paymentsconstraintsongrowthandinvestment.ontheotherhand,alargeproportionofforeigncapitalinflowshasoftenbeendirectedtoprivatebanksforfinancingconsumptionorspeculativefinancialinvestmentsthathavegeneratedassetpricebubbles.Moreover,whencapitalinflowsarenotusedforfinancingimportsofgoodsandservices,theyoftenleadtoastrongcurrencyappreciationthatmakesdomesticindustrieslesspricecompetitiveininternationalmarkets.Financialinflowsandoutflows,andtheirinstability,haveoftenledtolendingboomsandbusts,inflationarypressuresandthebuild-upofforeignliabilitieswithoutcontributingtoaneconomy’scapacitytogrowandservicesuchobligations.Adryinguporreversalofinflowsexertspressureonthebalanceofpaymentsandonthefinancingofboththeprivateandpublicsectors.Arelianceonprivatecapitalinflowshasthereforetendedtoincreasemacroeconomicandfinancialinstabilityandhamper,ratherthansupport,

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long-termgrowth.Moreover,privatecapitalflowshavebeenmostlyprocyclical.Forboththesereasons,theyhaveplayedamajorroleinbalance-of-paymentsandfinancialcrisesinthedevelopingworldoverthelastthreedecades.

Greaterrelianceondomesticcapitalmarketsforthefinancingofgovernmentexpenditurehelpsreducevulnerabilitytocreditcrunchesandexchange-rateinstability.Debtdenominatedinlocalcurrencyalsoallowsmonetaryauthoritiestocounterexternalshocksorgrowingtradedeficitswithadevaluationofthenominalexchangeratewithoutincreasingthedomesticcurrencyvalueofthatdebt.Finally,debtdenominatedinlocalcurrencyallowsthegovernmentalast-resortoptionofusingdebtmonetizationinatimeofcrisis,therebyreducingtheinsolvencyriskandloweringtheriskpremiumonthedebt.ontheotherhand,theamountanddirectionofforeigncapitalflowsarelargelydeterminedbyfactorsthatareoftenunrelatedtotheinvestmentandtrade-financingneedsofthereceivingcountriesandarebeyondthecontroloftheirauthorities.

Protective measures against external disturbances

Pragmatic exchange-ratemanagement aimed at preventing currency overvaluation can limit thedestabilizingeffectsofspeculativecapitalflows.inaddition,interestratedifferentials,whichoftenattractcarry-tradespeculation,canbelimitedwheninflationiskeptundercontrol.Thiscanbedonenotprimarilybymeansofarestrictivemonetarypolicyandhighpolicyinterestrates,butwiththehelpofotherinstruments,suchasanincomespolicythataimsatkeepingaveragewageincreasesinlinewith,andnotexceeding,productivitygrowthandtheinflationtargetofthecentralbank.

Destabilizingeffectsofcapitalflowscanalsobeprevented,oratleastmitigated,byresortingtocapitalcontrols,whicharepermittedundertheinternationalMonetaryFund’s(iMF)ArticlesofAgreement,andforwhichthereisextensiveexperienceinbothdevelopedanddevelopingcountries.WhiletheiMFhasrecentlyrecognizedthatcapitalcontrolsarelegitimateinstruments,itrecommendsresortingtothemonlyinsituationswhenabalance-of-paymentscrisisisalreadyevident,andafterallothermeasures(e.g.monetaryandfiscaladjustment)havefailed.Theproblemwithsuchanapproachisthatitdoesnotrecognizethemacroprudentialrolethatcontrolofcapitalinflowscanplayinpreventingsuchacrisisfromoccurringinthefirstplace.

Reconsidering regulation of the financial system

Thehypothesisthatderegulatedfinancialmarketsareefficientbecauseactorsinthesemarketspossessalltheinformationnecessarytoanticipatefutureoutcomes,andwillusethisinformationrationallysothatthefinancialsystemcanregulateitself,hasbeenrefutedbythepresentcrisis.Thisshouldpromptpolicymakersindevelopingandtransitioneconomiestodrawtheirownlessonsforshapingtheircountries’financialsystems.

Certainregulatorymeasuresthatarenowenvisagedindevelopedcountriesmayalsoberelevantandimportant to developing countries. Suchmeasures include, in particular, those aimed at improving thegovernanceofbanks,reducingincentivesforhighlyriskybehaviourofmarketparticipants,andresolutionmechanisms allowing authorities towinddownbadbanks and recapitalize institutions throughpublicownership.Theseparationofcommercialretailbanking(receivingdeposits,deliveringloansandmanagingpayments)fromriskyinvestmentbankingactivitiesisaprinciplethatshouldalsoguidebankregulationsindevelopingcountries.Thiswouldhelppreventindividualfinancialinstitutionsfromgrowingexcessivelylargeandassumingsuchadiversityofactivitiesthattheirperformancebecomessystemicallyimportant.Suchmeasuresmaybeeasiertoimplementincountrieswherefinancialsystemsarestillintheprocessoftakingshape,andwherethefinancialsectorisstillrelativelysmallbutboundtoexpandastheireconomiesgrow.

internationalstandardsandrulesrelatingtocapitalrequirementsandliquidityunderthebaselaccords,whichaimatreducingtheriskofbankfailureandtheneedforpublicbailoutsbycontainingexcessive

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leveraging,maynotalwaysbesuitedtothespecificcircumstancesandrequirementsofdevelopingcountries.Relativelysmallbanksindevelopingcountriesmayrequiredifferentrulesthanlarge,internationallyoperatingbanksindevelopedcountries.butitalsoneedstoberecognizedthatinmanyofthedevelopingcountrieswhichhaveexperiencedseriousbankingcrisessincethe1980s,capitalandliquidityrequirementsweremuchhigherthanthoseprescribedbythebaselrules,andthattheapplicationofthoserulesledtoarestrictionofbanklending,especiallytosmallandmedium-sizedenterprises(SMes).Thesecountriesshouldthereforebeallowedtoadaptprudentialrulestotheirspecificsituationandneeds.

inanycase,financialregulationshouldbeconceivedinsuchawaythatitisnotinimicaltogrowth.inparticular,itshouldencouragelong-termbanklendingtofinanceproductiveinvestmentanddiscouragelendingforunproductiveandspeculativepurposes.Thisisimportantbecauseoftheinterdependencebetweenfinancialstabilityandgrowth:financialstabilitysupportsgrowthbecauseitreducestheuncertaintythatisinevitablyinvolvedinanyfinancingoperation,whilestablegrowthsupportsfinancialstabilitybecauseitreducestheriskofloansbecomingnon-performing.

Monetary versus financial stability

Thecurrentexperienceinmajordevelopedcountriesshowsthatmassivemoneycreationbycentralbankshashadlittle,ifany,effectontheexpansionofcredittotheprivatesector.Thissuggeststhat,contrarytothemonetaristapproach,policymakersshouldfocusmoreonthevolumeofbankcreditthanonmoneycreationforpromotingfinancialstability.Moreover,thepurposesforwhichbankcreditisusedhaveanimpactonthelevelandcompositionofaggregatedemand.inprovidingcredit,bankscanplayakeyroleinensuringfinancialstability.Theyhavetodiscriminatebetweengoodandbadprojects,andreliableandunreliableborrowers,insteadofbehavinglikepassiveintermediaries,orlosinginterestintheeconomicperformanceoftheirborrowersaftersecuritizingtheirdebtandtransferringtherisktoanotherentity.

Theexperienceofthedevelopedcountriesinthepastfewyearshasshownthatmonetarystability,inthesenseofconsumerpricestability,cancoexistwithconsiderablefinancialinstability.intheeurozone,theeliminationofexchangerateriskandlowinflationevenservedtogeneratefinancialinstability:itfavouredlargecapitalflowsfrombanksinthecorecountriesofthezonetocountriesintheperipheryandthevirtualeliminationofinterestratedifferentialsbetweenthesetwosetsofcountries.However,thosecapitalflowswerenotusedforspurringcompetitivenessandproductioncapacities,butratherforfeedingbubblesandthefinancingofcurrentaccountdeficits.Thisamplifiedintraregionaldisparities,insteadofreducingthem,andgeneratedthecrisisinthedeficitcountrieswithinthecommoncurrencyarea.Thisoutcomeissimilartothatofmanydevelopingandtransitioneconomiesinpreviousdecades,particularlyinlatinAmericaandSouth-eastAsia,wheremonetarystabilitybasedonafixednominalexchangerateledtofinancialcrises.

Fostering the financing of domestic investment

Thefinancialsectorcanplayakeyroleinacceleratingeconomicgrowththroughthefinancingoffixedcapitalformationthatboostsproductionandgeneratesemployment.Thus,inordertosupportdevelopmentstrategiesthatpromotedomesticdemandasadriverofgrowth,itisessentialfordevelopingcountriestostrengthentheirfinancialsystems.

Retainedprofitsconstitutethemostimportantsourceforthefinancingofinvestmentinrealproductivecapacity.Atthesametime,risingdemandisdecisiveforhelpingtomeetexpectationsofprofitabilityofadditional investment in productive capacity, and that profitability in turnfinances private investment,resulting in a strongprofit-investment nexus. in addition, bank credit is essential, although its relativeimportancedependsoncountry-specificcircumstances.bankfinancingenablesfirms toaccelerate their

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capitalformationoverandabovewhatispossiblefromretainedprofits.Therefore,growthdynamicsdependcriticallyontheavailabilityofsufficientamountsofbankcreditatacostthatiscommensuratewiththeexpectedprofitabilityofinvestmentprojects.Thebankingsystemasawholecanprovideinvestmentcreditwithoutthepriorexistenceofacorrespondingamountoffinancialsavings.Thecentralbankcansupportthecreationofsuchcreditthroughtheprovisionofadequateliquiditytothebankingsystemandbykeepingthepolicyinterestrateaslowaspossible.

beyondthat,governmentinterventionmayfacilitateaccesstocredit,especiallyforsectorsandfirmsengagedinactivitiesthatareofstrategicimportanceforthestructuraltransformationandgrowthoftheeconomy.onepossibilitymaybetheprovisionofinterestsubsidiesforthefinancingofinvestmentinareasofactivity thatareconsideredtobeofstrategic importance;another is influencingthebehaviourof thebankingsysteminthewayitallocatescredit.

The banking system and credit orientation

Publicinterventionintheprovisionofbankcreditwillbeespeciallyimportantindevelopingcountriesthat are aiming at strengthening domestic forces of growth, since long-term loans for investment andinnovation,aswellas loans tomicro,smallandmedium-sizedenterprisesareextremelyscarceeveningoodtimes.Commercialbanksindevelopingcountriesoftenprefertograntshort-termpersonalloansortobuygovernmentsecurities,becausetheyconsidertherisksassociatedwithmaturitytransformation(i.e.providinglong-termcreditsmatchedbyshort-termdeposits)tobetoohigh.

A revised regulatory framework could include elements that favour a different allocationof bankassetsandcreditportfolios.bankscouldbeencouraged,orobliged,toundertakeamorereasonabledegreeofmaturitytransformationthaninthepast.Publicguaranteesforcommercialbankcreditforthefinancingofprivateinvestmentprojects,mayencourageprivatecommercialbankstoprovidemorelendingforsuchpurposes.Sucharrangementswouldreducethecreditdefaultrisk,andhencealsotheriskpremiumonlong-terminvestmentloans.Theresultinglowerinterestcostforinvestorswouldfurtherreducetheprobabilityofloanlossesandthusthelikelihoodofrequiringgovernmentstocoversuchlossesunderaguaranteescheme.

Similarly,withintheframeworkofacomprehensiveindustrialpolicy,co-financingbyprivatebanks,whichtakeamicroeconomicperspective,andpublicfinancialinstitutionsthatactintheinterestofsocietyasawhole,couldhelptoensurethatinvestmentprojectsarebothcommerciallyviableandsupportastrategyofstructuralchangeintheeconomyatlarge.

Therearemanyexampleswherecreditpolicyhasbeenimplementedwiththehelpofvariouspublic,semi-publicandcooperativespecializedinstitutionswhichhavefinancedagriculturalandindustrialinvestmentbySMes at preferential rates.National developmentbanksmayprovidefinancial services that privatefinancialinstitutionsareunableorunwillingtoprovidetotheextentdesired.Suchbanksplayedanimportantcountercyclicalroleduringthecurrentcrisiswhentheyincreasedlendingjustasmanyprivatebankswerescalingbacktheirs.inaddition,smaller,morespecializedsourcesoffinancealsohaveanimportantroletoplayintheoveralldynamicsofthedevelopmentprocess.

Changing views about the role of central banks

Strengtheningthesupportiveroleofthebankingsystemmayalsorequirereviewingthemandateofcentralbanks,andevenreconsideringtheprincipleofcentralbankindependence.indeed,thetraditionalroleofcentralbanksonlyasdefendersofpricestabilitymaybetoonarrowwhentherequirementsofdevelopmentandtheneedtostabilizethefinancialsectoraretakenintoaccount.

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Theiruseofmonetarypolicyasthesoleinstrumentforfightinginflationhasoftenledtohighrealinterestratesthatdiscouragedprivatedomesticinvestmentandattractedforeigncapitalinflowsofaspeculativenature.Thistendedtoleadtocurrencyovervaluationwithaconsequentdecreaseinexports,andthusaloweringofdemandexpectationsofdomesticproducers.Anincomespolicybasedonproductivity-relatedwagegrowthwouldfacilitatetheconductofmonetarypolicy,becauseitwouldexclude,oratleastsignificantlyreduce,theriskofinflationgeneratedbyrisingunitlabourcosts.Thiswouldfacilitatethetaskofthecentralbankstogeartheirmonetarypolicymoretothecreationoffavourablefinancingconditionsfordomesticinvestment.

Theneedforreconsideringtheroleofcentralbankshasneverbeenmoreevidentthanduringthelatestfinancialcrisis.Centralbankindependencedidnotpreventthiscrisis,butwheniteruptedthesebankshadtotake“unconventional”measurestostabilizefinancialmarketsintheinterestsoftheeconomyasawhole,ratherthansimplymaintainingpricestability.Theconcertedactionofcentralbanksandgovernmentswasindispensableintacklingtheeffectsofthecrisis,includingbybailingoutinstitutionsthatwereconsidered“toobigtofail”.Thisexperiencehasledtoarecognitionthatcentralbankscanmakeamajorcontributiontothestabilityoffinancialmarketsandthebankingsystem.

Afurtherstepwouldbetorecognizethatcentralbankscanplayanactiveroleintheimplementationofagrowthanddevelopmentstrategy.Sincefinancialstabilitydependsontheperformanceoftherealsectorof the economy,bolstering economicgrowth should alsobe considered amajor responsibilityof theseinstitutions.Theycansupportmaturitytransformationinthebankingsystemthroughtheirroleaslendersoflastresortandtheirprovisionofdepositinsurance.Thelatterreducestheriskofasuddenwithdrawalofdeposits,whichwouldcauseliquidityconstraintsforbanks,whiletheformercouldrespondtoliquidityshortages,shouldtheyoccur.buttherearealsonumerousexamplesfrombothdevelopedanddevelopingcountriesofcentralbankinvolvementindirectingcredit, through,forexample,directfinancingofnon-financialfirms,selectiverefinancingofcommercialloansatpreferentialrates,orexemptingcertaintypesofbanklendingfromquantitativecreditceilings.

Theseschemesplayedapivotalroleintherapidindustrializationofmanycountries.However,theydidnotalwaysdelivertheexpectedoutcomes.Forexample,inseveralcountrieswherepublicbankssometimesprovidedcredittootherpublicentitiesforpurposesthatwerenotrelatedtoproductiveinvestment,non-performingloansburdenedtheirbalancesheetsandunderminedtheirlendingcapacities.butitalsoneedstoberecognizedthatitwastheprivatizationofpublicbanksandthederegulationoffinancialsystemsthatpavedthewaytomajorfinancialcrisesinlatinAmericaandineastandSouth-eastAsia.inlightofthesedifferentexperiences,developingcountriesneedtocarefullyweightheprosandconsofgovernmentinvolvementincreditallocationwhenshapingorreformingtheirdomesticfinancialsectors.Theyshouldalsoimplementwell-designedgovernanceandcontrolmechanismsforbothpublicandprivatefinancialinstitutionsinordertoensurethattheseinstitutionsoperateintheinterestsoftheeconomyandsocietyasawhole.

SupachaiPanitchpakdi Secretary-GeneralofUNCTAD

Current Trends and Challenges in the World Economy 1

1. Global growth

Theglobaleconomyisstillstrugglingtoreturntoastrongandsustainedgrowthpath.Worldoutput,whichgrewatarateof2.2percentin2012,isforecasttogrowatasimilarratein2013.Developedcountrieswillcontinuetolagbehindtheworldaverage,withalikely1percent increaseingrossdomesticproduct(GDP),duetoaslightdecelerationintheUnitedStatesandacontinuingrecessionintheeuroarea.Developingandtransitioneconomiesshouldgrowbyabout4.7percent and2.7per cent respectively (table1.1).eventhoughthesegrowthratesaresignificantlyhigherthanthoseofdevelopedcountries,theyremainwellbelowtheirpre-crisislevels.Furthermore,theyconfirmthepaceofdecelerationthatstartedin2012.

economicactivityinmanydevelopedcountriesandanumberofemergingmarketeconomiesisstillsufferingfromtheimpactsofthefinancialandeco-nomiccrisisthatstartedin2008andthepersistenceof domestic and international imbalances that ledtoit.However,continuingweakgrowthinseveralcountriesmay also be partly due to their currentmacroeconomicpolicystance.

Amongdeveloped economies, growth in theeuropeanUnion (eU) is expected to shrink for thesecond consecutive year,with a particularly severeeconomiccontractionintheeuroarea.Privatedemandremainssubdued,especiallyintheeuro-zoneperipherycountries(Greece,ireland,italy,PortugalandSpain),duetohighunemployment,wagecompression,lowconsumerconfidenceandthestillincompleteprocessofbalancesheetconsolidation.Given theongoingprocess of deleveraging, expansionarymonetarypolicieshavefailedtoincreasethesupplyofcreditforproductiveactivities.inthiscontext,continuedfiscaltighteningmakesareturntoahighergrowthtrajectoryhighlyunlikely,asitaddsadeflationaryimpulsetoalreadyweakprivatedemand.Whilefor-eigntrade(mainlythroughthereductionofimports)contributedtogrowthintheeuroarea,thiswasmorethan offset by the negative effect of contractingdomesticdemand,whicheventhesurpluscountrieshavebeen reluctant to stimulate.This perpetuatesdisequilibriumwithintheeurozoneandreducesthescopeforanexport-ledrecoveryofothercountriesinthezone.Hence,despitethefactthatthetensionsinthefinancialmarketsoftheeuroareahaverecededfollowing intervention by the europeanCentralbank(eCb),prospectsforaresumptionofgrowth

Chapter I

CURRENT TRENDS AND ChALLENGES IN ThE wORLD ECONOMy

A. Recent trends in the world economy

Trade and Development Report, 20132

Table 1.1

World output groWth, 2005–2013(Annual percentage change)

Region/country 2005 2006 2007 2008 2009 2010 2011 2012 2013a

World 3.5 4.1 4.0 1.5 -2.2 4.1 2.8 2.2 2.1

developed countries 2.4 2.8 2.6 0.0 -3.8 2.6 1.5 1.2 1.0of which:

Japan 1.3 1.7 2.2 -1.0 -5.5 4.7 -0.6 1.9 1.9United States 3.1 2.7 1.9 -0.3 -3.1 2.4 1.8 2.2 1.7European Union (EU-27) 2.1 3.3 3.2 0.3 -4.3 2.1 1.6 -0.3 -0.2of which:

Euro area 1.7 3.3 3.0 0.4 -4.4 2.0 1.5 -0.6 -0.7France 1.8 2.5 2.3 -0.1 -3.1 1.7 2.0 0.0 -0.2Germany 0.7 3.7 3.3 1.1 -5.1 4.2 3.0 0.7 0.3Italy 0.9 2.2 1.7 -1.2 -5.5 1.7 0.4 -2.4 -1.8

United Kingdom 2.8 2.6 3.6 -1.0 -4.0 1.8 0.9 0.2 1.1

South-East Europe and CIS 6.5 8.3 8.6 5.2 -6.6 4.5 4.5 3.0 2.7

South-East Europeb 4.7 4.8 5.5 3.7 -4.3 0.0 1.1 -1.4 0.3CIS 6.7 8.7 8.9 5.3 -6.8 4.9 4.8 3.4 2.9of which:

Russian Federation 6.4 8.2 8.5 5.2 -7.8 4.5 4.3 3.4 2.5

developing countries 6.8 7.6 7.9 5.3 2.4 7.9 5.9 4.6 4.7Africa 5.8 5.9 6.2 5.2 2.8 4.9 1.0 5.4 4.0

North Africa, excl. Sudan 5.1 5.4 4.7 4.6 3.2 4.1 -6.1 7.8 3.6Sub-Saharan Africa, excl. South Africa 6.7 6.5 7.7 6.6 4.9 6.4 4.8 5.3 5.4South Africa 5.3 5.6 5.5 3.6 -1.5 3.1 3.5 2.5 1.7

Latin America and the Caribbean 4.5 5.6 5.6 4.0 -1.9 5.9 4.3 3.0 3.1Caribbean 7.4 9.4 5.8 3.1 -0.1 2.6 2.4 2.5 2.7Central America, excl. Mexico 4.8 6.4 7.0 4.1 -0.2 4.1 5.2 5.0 4.1Mexico 3.2 5.2 3.3 1.2 -6.0 5.5 4.0 3.9 2.8South America 5.0 5.5 6.6 5.5 -0.2 6.4 4.6 2.5 3.2of which:

Brazil 3.2 4.0 6.1 5.2 -0.3 7.5 2.7 0.9 2.5Asia 7.8 8.6 9.0 5.8 3.9 8.9 7.1 5.0 5.2

East Asia 8.6 9.9 11.0 6.9 5.9 9.5 7.7 6.0 6.1of which:

China 11.3 12.7 14.2 9.6 9.2 10.4 9.3 7.8 7.6South Asia 8.0 8.3 8.9 5.2 4.7 9.4 6.6 3.0 4.3of which:

India 9.0 9.4 10.1 6.2 5.0 11.2 7.7 3.8 5.2South-East Asia 5.8 6.1 6.6 4.3 1.2 8.0 4.5 5.4 4.7West Asia 6.8 7.0 4.6 3.8 -1.7 7.0 7.1 3.2 3.5

Oceania 3.4 2.9 3.5 2.7 2.3 3.6 4.3 4.1 2.7

Source: UNCTAD secretariat calculations, based on United Nations, Department of Economic and Social Affairs (UN-DESA), National Accounts Main Aggregates database, and World Economic Situation and Prospects (WESP): Update as of mid-2013; ECLAC, 2013; ESCAP, 2013; OECD, 2013; IMF, World Economic Outlook, April 2013; Economist Intelligence Unit, EIU CountryData database; JP Morgan, Global Data Watch; and national sources.

Note: Calculations for country aggregates are based on GDP at constant 2005 dollars. CIS includes Georgia.a Forecasts.b Albania, Bosnia and Herzegovina, Croatia, Montenegro, Serbia and the former Yugoslav Republic of Macedonia.

Current Trends and Challenges in the World Economy 3

of consumption and investment in these countriesremaingrim.

Japanisbuckingthecurrentausteritytrendofother developed economies byproviding a strongfiscalstimulusinconjunctionwithmonetarypolicyexpansionwiththeaimofrevivingeconomicgrowthand curbing deflationary trends.An increase ofgovernment spendingon infrastructure and socialservices, includinghealth care and education, hasbeen announced, to be accompanied by efforts toboostdemandandstructuralpoliciesorientedtowardsinnovation and investment.To complement theseefforts,inApril2013thebankofJapanannouncedthatitwillincreaseitspurchaseofgovernmentbondsandotherassetsby50trillionyenperyear(equivalentto10percentofJapan’sGDP)inordertoachieveaninflationtargetof2percent.overall,thesemeasurescouldhelpmaintainJapan’sGDPgrowthatcloseto2percentin2013.

TheUnitedStatesisexpectedtogrowat1.7percent,comparedwith2.2percentin2012,duetoanewconfigurationoffactors.Partlyowingtosignificantprogressmade in the consolidationof its bankingsector,privatedomesticdemandhasbeguntorecover.Thepaceof job creation in the private sector hasenabledagradualfallintheunemploymentrate.ontheotherhand, cuts in federalgovernment spend-ing,enactedinMarch2013,andbudgetconstraintsfacedbyseveralStateandmunicipalgovernmentsareastrongdragoneconomicgrowth.Sincethenetoutcomeof these opposing tendencies is unclear,thereisalsoconsiderableuncertaintyaboutwhetherthe expansionarymonetary policy stancewill bemaintained.

bycontrast, developing countriescontinuetobethemaindriversofgrowth,contributingtoabouttwothirdsofglobalgrowthin2013.inmanyofthem,growthhasbeendrivenmorebydomesticdemandthan by exports, as external demand, particularlyfrom developed economies, has remainedweak.Developing countries are expected to grow at therateof4.5–5percentin2013,similarto2012.Thiswouldresultfromtwodistinctivepatterns.ontheonehand,growthinsomelargedevelopingeconomies,suchasArgentina,brazil,indiaandTurkey,whichwassubduedin2012,isforecasttoaccelerate.ontheotherhand,severalotherdevelopingeconomiesseemunlikelytobeabletomaintaintheirpreviousyear’sgrowth rates.Their expected growth deceleration

partlyreflectstheaccumulatedeffectofcontinuingsluggishness in developed economies and lowerpricesforprimarycommodityexports,butalsothedecreasingpolicystimuliwhichwererelativelyweakanyhow.ThecombinationofthesefactorsmayalsoaffectChina’sgrowthrate,whichisexpectedtoslowdownmoderatelyfrom7.8percentin2012toabout7.6in2013.eventhoughthiswouldbeonlyamilddeceleration,itislikelytodisappointmanyofChina’stradingpartners.

Among the developing regions,East, South andSouth-East Asiaareexpectedtoexperiencethehighestgrowthratesin2013,of6.1percent,4.3percentand4.7percent,respectively.inmostofthesecountries, growth is being driven essentially bydomesticdemand.inChina,thecontributionofnetexportstoGDPgrowthwasnegligible,whilefixedinvestment and private consumption, as a resultof fasterwage growth, continued to drive outputexpansion.encouragedbyvarious incomespolicymeasures,domesticprivatedemandisalsosupport-ingoutputgrowthinanumberofothercountriesintheregion,suchasindia,indonesia,thePhilippinesandThailand(eSCAP,2013).inaddition,alongwithGDPgrowth,credittotheprivatesectorhastendedtorise,furthersupportingdemand.

economicgrowth inWest Asia sloweddowndramatically, from7.1percent in2011 to3.2percent in 2012, a level that is expected to bemain-tainedin2013.Weakerexternaldemand,especiallyfromeurope, affected the entire region, butmostprominentlyTurkey,whichsawitsgrowthratefallsharplyfromaround9percentin2010and2011to2.2percentin2012,butitisexpectedtoacceleratetowards3.3percentin2013.TheGulfCooperationCouncil (GCC) countriesmaintained large publicspendingprogrammestobolsterdomesticdemandandgrowth,despitescalingbacktheiroilproductionduringthelastquarterof2012tosupportoilprices.Finally,thecivilwarintheSyrianArabRepublicnotonlygreatlyaffectedthatcountrybutcontinuedtoheightenperceptionsofriskwithregardtoneighbour-ingcountries,whichresultedinsubduedinvestment,tourismandtradeinJordanandlebanon.

Growth inAfrica is expected to slow downin 2013, owing toweaker performance inNorthAfrica,wherepoliticalinstabilityinsomecountrieshasbeenmirroredinrecentyearsbystrongfluctua-tions in growth. in sub-SaharanAfrica (excluding

Trade and Development Report, 20134

SouthAfrica),GDPgrowth is expected to remainstablein2013,atabove5percent.Themaingrowthdrivers includehighearnings fromexportsofpri-marycommoditiesandenergyaswell as tourism,and relativelystronggrowthofpublicandprivateinvestmentinsomecountries.Angola,Côted’ivoire,theDemocraticRepublic of theCongo,ethiopia,Gambia,Ghana, liberia, Rwanda, Sierra leoneand theUnitedRepublicofTanzaniaare likely tosee rapidgrowthbolsteredby strong investments,especially in infrastructure, telecommunications,energy and the extractive industries.on theotherhand,growthinseveralmiddle-incomecountriesofAfrica is forecast todecelerate further in2013, inparticularincountriesthathaveclosetradetieswitheurope,includingSouthAfrica.Moreover,severalleast developed countries (lDCs) ofWestAfricawhich depend on exports of single commoditiesremainvulnerabletodrasticswingsindemandforthosecommodities.

GrowthissettoremainrelativelystableinLatin America and the Caribbean,ataround3percent,onaverage,asaslowdowninsomecountries,includ-ingMexico,islikelytobeoffsetbyfastergrowthinArgentinaandbrazil.in2012andthefirstmonthsof2013,regionalgrowthhasbeendrivenmostlybydomesticdemandbasedonmoderatebutconsistentincreases in public and private consumption andinvestment (eClAC, 2013).Governments gener-allyturnedtomoresupportivefiscalandmonetarypolicies inacontextof lowfiscaldeficitsandlowinflationfortheregionasawhole.Growthofexportsandimportsfellsharplyin2012,whichresultedinaslightincreaseintheregion’scurrentaccountdeficit.Domesticdemandwillcontinuetosupportgrowthin2013basedonrisingrealwagesandemployment,aswellasanexpansionofbankcredit.inaddition,arecoveryofagricultureandinvestmentshouldcon-tributetobettereconomicperformancesinArgentinaandbrazilafterweakgrowthin2012.ontheotherhand,owing to sluggish internationaldemandandlower export prices of oil andmining products(althoughtheyremainathistoricallyhighlevels)aslowdownisexpectedinthebolivarianRepublicofVenezuela,Chile,ecuador,MexicoandPeru.

Therehasbeenadownwardtrendintheeco-nomicperformanceofthetransition economiessince2012.TheimpactofthecontinuingcrisisinmuchofWesterneuropecausedtheeconomiesofSouth-easterneuropetofallintorecessionin2012,andthey

willbarelyremainafloatin2013.ThemembersoftheCommonwealthofindependentState(CiS)main-tainedagrowthrateofover3percentin2012basedonsustaineddomesticdemand,butthisisexpectedtoslowdownslightlyin2013.Theregion’seconomicprospectsremaincloselylinkedtotheperformanceof the economyof theRussianFederation and tocommoditypricedevelopments,particularly inoilandnaturalgas.

Thecontinuingexpansionofdevelopingecono-miesasagroup(inparticularthelargesteconomyamongthem,China)hasledtotheirgainingincreas-ingweight in theworld economy,which suggeststhepossibleemergenceofanewpatternofglobalgrowth.Whiledevelopedcountriesremainthemainexportmarketsfordevelopingcountriesasagroup,theshareofthelatter’scontributiontogrowthintheworld economyhas risen from28per cent in the1990stoabout40percentintheperiod2003–2007,andcloseto75percentsince2008.However,morerecently,growthintheseeconomieshasdecelerated.TheymaycontinuetogrowatarelativelyfastpaceiftheyareabletostrengthendomesticdemandandiftheycanrelymoreoneachotherfortheexpansionofaggregatedemandthroughgreaterSouth-Southtrade.However,eveniftheyachievemorerapidgrowthbyadoptingsuchastrategy,andincreasetheirimportsfromdevelopedcountries,thiswillnotbesufficienttoliftdevelopedcountriesoutoftheirgrowthslump.

2. International trade

(a) Goods

internationaltradeingoodshasnotreturnedtotherapidgrowthrateoftheyearsprecedingthecrisis.onthecontrary,itdeceleratedfurtherin2012,andwhiletheoutlookforworldtraderemainsuncertain,thefirstsignsin2013donotpointtoanexpansion.Afterasharpfallin2008–2009andaquickrecoveryin2010,thevolumeoftradeingoodsgrewbyonly5.3per cent in2011andby1.7per cent in2012.Thisslowerrateofexpansionoccurredindeveloped,developingandtransitioneconomiesalike(table1.2).

Sluggisheconomicactivityindevelopedcoun-tries,particularlyineurope,accountedformostofthisverysignificantslowdown.in2012,eUimports

Current Trends and Challenges in the World Economy 5

ofgoodsshrankby2.8percentinvolumeandby5percentinvalue.extremelyweakintra-eUtradewasresponsibleforalmost90percentofthedeclineineurope’sexportsin2012.However,tradeperfor-mancewasalsoweakinotherdevelopedcountries.inJapan,exportshavenotyetrecoveredfromtheirsharpfallcausedbytheearthquakeof2011,1whilethevolumeofitsimportshascontinuedtogrowatamoderatepace.Amongtheothermajordevelopedcountries,onlytheUnitedStatesmaintainedaposi-tivegrowthrateofbothexportsandimports,althoughthatofitsexportsappearstobedeceleratingfurtherin2013.Thissignalsamountingheadwindfortheworld’s largest economy,where exports initiallyappearedtospurarecovery.

Tradegrowthalsodeceleratedconsiderablyindevelopingandtransitioneconomiesin2012,thoughthefiguresremainedpositiveformostcountries.inthetransitioneconomies,therateofgrowthofthevolumeof exportswas 1 per cent in 2012, downfrom4.2percentin2011,andthatofimportswas

3.9percentin2012,downfrom15.7percentin2011.likewise,indevelopingcountriestherateofgrowthofexportsfellfrom6percentin2011to3.6percentin2011,andthatofimportsfrom7.4percentin2011to4.5percentin2012.

Atthesubregionallevel,twonotableexceptionsstandout from thisgeneralpatternofdeveloping-country trade.Thefirst is the recoveryof trade insomeNorthAfricaneconomiesfromlowlevelsin2011,whichcontributed tohigher tradegrowth inAfricaasawhole.ThesecondistheabsolutedeclineinthevolumeofexportsfromSouthAsia,explainedmainlybyareductionofoilexportsfromtheislamicRepublic of iran,2 though india’s export volumesalsofell,by2.5percent.Thiswaslargelyduetotheeconomicslowdownineurope,whichaccountsforalmostonefifthofindia’stotalexports,aswellasweakexportstoChina.

Anexaminationoflongertimeperiodsputsintoperspectivethestructuralchangesassociatedwiththe

Table 1.2

ExPORT AND IMPORT VOLUMES OF GOODS, SELECTED REGIONS AND COUNTRIES, 2009–2012(Annual percentage change)

Volume of exports Volume of imports

Region/country 2009 2010 2011 2012 2009 2010 2011 2012

world -13.3 13.9 5.2 1.8 -13.6 13.8 5.3 1.6Developed countries -15.5 13.0 4.9 0.4 -14.6 10.8 3.4 -0.5of which:

Japan -24.8 27.5 -0.6 -1.0 -12.2 10.1 4.2 3.7United States -14.0 15.4 7.2 4.1 -16.4 14.8 3.8 2.8European Union -14.9 11.6 5.5 -0.2 -14.5 9.6 2.8 -2.8

Transition economies -14.4 11.3 4.2 1.0 -28.2 15.9 15.7 3.9of which:

CIS -13.9 11.4 4.2 1.3 -29.1 19.7 17.4 5.0

Developing countries -9.7 16.0 6.0 3.6 -10.2 18.8 7.4 4.5Africa -9.5 8.8 -8.3 5.7 -6.2 8.4 2.8 8.0

Sub-Saharan Africa -7.8 9.6 -0.7 0.1 -9.0 9.7 7.9 4.2Latin America and the Caribbean -7.4 8.3 4.6 2.2 -17.9 22.5 10.8 2.5East Asia -10.9 24.1 10.4 5.2 -5.3 22.7 7.4 4.3of which:

China -14.1 29.1 13.0 7.2 -1.1 25.4 10.3 5.9South Asia -6.1 10.0 8.8 -10.2 -5.5 14.0 6.0 2.0of which:

India -6.8 14.0 14.2 -2.5 -0.9 13.8 9.1 5.8South-East Asia -10.0 18.6 4.4 2.2 -15.8 22.0 6.7 6.0West Asia -4.8 5.7 6.5 6.9 -14.2 8.4 8.1 5.8

Source: UNCTAD secretariat calculations, based on UNCTADstat.

Trade and Development Report, 20136

slowdownoftrade.bytheendof2012,thevolumeofglobaltradewasonly7.5percentaboveits2007level.Theaverageannualgrowthrateduringtheperiod2008–2012wasabout1.4percent–wellbelowthe7.4percentregisteredduringtheperiod2003–2007.

WithregardtoChina,thepowerhouseofglobaltrade in recent years, the slowdown is evenmorestriking.Theworld’s largest exporter experiencedasharpdecelerationofitsexportsasaconsequenceofthe2008–2009economiccrisis,largelyduetoitsrelianceondemandfromdevelopedcountries.TherateofgrowthofChina’sexports(byvolume)decel-eratedto13percentin2011andto7.2percentin2012,insharpcontrasttotheirmassivegrowthrateof27percentduringtheperiod2002–2007followingChina’saccessiontotheWorldTradeorganization(WTo).ThiswasthefirsttimesincetheeastAsiancrisis in thelate1990sthatChina’sexportgrowthwasslowerthanthatofitsGDP.Concomitantly,in2012, thegrowthofChina’s importsdeceleratedto5.9percentbyvolumeandto4.3percentbyvalue,from19percentand26percent,respectively,between2002and2007.Asaresult,onlyregionsexportingalargeproportionofprimarycommodities(i.e.Africa,WestAsia and, to a lesser extent,latinAmerica)sawasignificantincreaseintheirexportstoChinain2012,bothbyvolumeandvalue.

SeveralexportersofmanufacturesinAsiaregis-teredasizeableslowdownofgrowthintheirexternaltrade. For example, between 2002 and 2007, thevolumeofexportsoftheRepublicofKorea,ThailandandMalaysia increased by an annual average of14percent,10percentand9percent,respectively;in2012,thoseratesfellto1.5percentintheRepublicofKorea,2.5percentinThailandand0.5percentinMalaysia.Thiswastheresultnotonlyoflowerimportdemandfromeurope,butalsoofslowergrowthinsomedevelopingregions,inparticulareastAsia.

Thecrisisof2008–2009alteredtradepatternsinbothdevelopedanddevelopingcountries.ontheonehand,importsandexports(byvolume)ofdevel-opedregionshave remainedbelow theirpre-crisislevels,withtheexceptionoftheUnitedStateswhereexportshaveexceededtheirpreviouspeakofAugust2008.ontheotherhand,exportsfromthegroupofemergingmarketeconomieswere22percentabovetheirpre-crisispeaks,whilethecorrespondingfigurefortheirimportswas26percenthigher.However,thepaceofgrowthoftradeoftheseeconomieshas

slowed down significantly: during the pre-crisisyears,between2002and2007,theirexportvolumegrewatanaverageannualrateof11.3percent,butfelltoonly3.5percentbetweenJanuary2011andApril2013.Growthinthevolumeoftheirimportsalsosloweddown,from12.4percentto5.5percentoverthesameperiod(chart1.1).

Availabledataforthefirsthalfof2013tendtoconfirmthattherecentslowdownpersists.DatafromtheCPbNetherlandsbureauforeconomicPolicyAnalysis(CPb)showthatthevolumeofinternationaltradegrewbyayear-on-year averageof less than2percentinthefirstfivemonthsof2013.AmongthedevelopedcountriesexportsandimportsvirtuallystagnatedintheUnitedStatesandfellintheeUandJapan.exportsfromemergingeconomiesdeceleratedduringthesameperiod,withtheexceptionofthosefromtheemergingAsianeconomies,whichincreasedby6.2percentinthefirstmonthsof2013.3

overall,thisgeneraldownwardtrendininterna-tionaltradehighlightsthevulnerabilitiesdevelopingcountries continue to face at a time of lacklustregrowthindevelopedcountries.itisalsoindicativeofaprobablylessfavourableexternaltradeenvironmentoverthenextfewyears,whichpointstotheneedforagradualshiftfromtherelianceonexternalsourcesofgrowthtowardsagreateremphasisondomesticsources.

(b) Services

Similar tomerchandise trade,world trade incommercialservicesgrewby1–2percentin2012,according to preliminary estimates byUNCTAD/WTo.Within this broad category, internationaltourismgrewby4percentin2012,bothintermsofreceiptsinrealterms(i.e.adjustingforexchangeratefluctuations and inflation) and the number ofarrivals.Tourismroughlyaccountsfor30percentofworldexportsofservicesandfor6percentofoverallexportsofgoodsandservices.italsoranksfifthasaworldwideexportcategoryafterfuels,chemicals,foodandautomotiveproducts,andevenfirstinmanydeveloping countries.TheAmericas recorded thelargestincreaseinreceiptsfromtourism(7percent),followedbyAsiaandthePacific(6percent),Africa(5percent)andeurope (2percent).bycontrast,receiptsinWestAsiawereagaindownby2percent(WorldTourismorganization,2013).Touristreceipts

Current Trends and Challenges in the World Economy 7

ofthetop10destinations,whichinclude7developedeconomiestogetherwithChina,HongKong(China)andMacao(China),remainedvirtuallyunchangedin2012,whereasseveralemergingmarketdestinations,includingindia,SouthAfrica,Thailand,UkraineandVietNamregistereddouble-digitgrowthfigures.

Thegrowthofinternationaltransportservices–thesecondlargestcategoryofcommercialservices–whilepositive,washinderedbyanumberofdown-sidefactors,includingthecontinuedrecessionintheeuroarea,fragilerecoveryintheUnitedStates,andtherelativedecelerationandrebalancingofgrowthoftheChineseeconomy.Preliminarydataindicatethatworld seaborne trade– ameasureofdemandforshipping,portand logisticsservices–climbedby4.3percentin2012.

inparticular,drybulktradeexpandedby6.7percentin2012,inlinewiththelong-termtrend,drivenmainlybytwomaincommodities–ironoreandcoal.Tradeinironoreroseby5.4percent,thoughthiswasconsideredtheslowestincreaseinmorethanadecade.A strong increase inChina’s demandwasmetbyexportsfromAustraliaand,toalesserextent,by long-haul shipments frombrazil.Meanwhile,

importsfromindia,previouslyChina’sthirdlargestsupplier,droppedbyover50percentasaresultofrisingexporttaxesonironoreaswellasminingandexportbans.Coalshipmentsincreasedsignificantly(12.3percent)drivenbystrongdemandforsteamcoal(14.2percent)stemmingfromtherecoveryineuropeanimportsandrapidlygrowingimportsbyChina.intheUnitedStates,greateruseofdomesti-callyproducedshalegasresultedinanincreaseinitscoalexports,whichinturnloweredinternationalcoalpricesanddroveupglobaldemandforcoal.

Developmentsintankertrade,whichaccountsforonethirdofglobalseabornetrade,mirroredthebehaviourofglobaloildemand. in2012,demandforcrudeoil increasedmarginallyby1.5percentinvolume.Meanwhile,thegrowthofcontainerizedtradedeceleratedto3.2percent,from7.1percentin 2011.The volumes of such trade continued tobeaffectedbyweakperformanceonthemain-laneeast-WestrouteslinkingAsiatoeuropeandNorthAmerica.Growthwasmainlydrivenbyanincreasein that trade on secondary routes, in particular,South-South,North-Southandintraregionalroutes.Containerizedtradeaccountsforabout16percentofglobalmerchandisetradebyvolumeandover50per

Chart 1.1

wORLD TRADE by VOLUME, JANUARy 2004–APRIL 2013(Index numbers, 2005 = 100)

Source: UNCTAD secretariat calculations, based on CPB Netherlands Bureau of Economic Policy Analysis, World Trade database.Note: Emerging market economies excludes Central and Eastern Europe.

80

100

120

140

160

180

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Volume of exports

80

100

120

140

160

180

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Volume of imports

World Developed countries Emerging market economies

Trade and Development Report, 20138

centbyvalue,butitremainsunderseverepressure.Theindustrycontinuestofacetheproblemofhowtoabsorbexcessshippingsupplycapacity,aswellashowtoemploytherapidlygrowingcapacityofverylargeshipswhenmostofthegrowthisbeinggener-atedbyregionaltradewhichrequiresmedium-sizedorsmallercontainerships(UNCTAD,2013).

3. Recent trends in commodity prices

During2012andthefirstfivemonthsof2013,the prices ofmost commodity groups continuedto retreat from their peaks reached in early 2011(chart1.2).Majorexceptionswerethepricesoffoodandoil,whichhavebeenfluctuatingwithinabandover thepast twoyears.Themain reasons for thedeclineinmanycommoditypricesoverthisperiodwereweakdemandgrowthandanuncertainoutlookforglobaleconomicactivity,togetherwithimprovedsupplyprospects.However,mostcommoditypricesstill remain at substantially higher levels than theaveragepricesrecordedduringthecommoditypriceboomof2003–2008(table1.3).

Pricesoffoodandvegetableoilseedsandoilssurgedinmid-2012asaresultofreducedsuppliescausedbyweather-relatedevents,mostnotablytheworstdroughtintheUnitedStatesinhalfacentury.Food cropswere also adversely affected byunfa-vourableclimaticconditionsintheblackSeaareaandinAustralia.Whiletheincreaseinthepricesoffoodcommoditiessuchascorn,wheatandsoybeanswas alarming, a food crisiswas avoidedmainlybecauserice,whichiscriticalforfoodsecurity,wasnotaffected,andcountriesrefrainedfromimposingtraderestrictions.Foodpricesfellinthesecondpartoftheyearowingtobettersupplyprospects.Afterthetightmarketsandhighpricesof2012/2013,forecastsfor2013/14pointtoabetterworldcerealsupplyanddemandbalance(FAo,2013).Withgoodprospectsforproductionandreplenishmentofstocks,pricesshouldease.Thisisnotthecase,however,forsoy-beans,which,inmid-2013,recordedariseinpricesresulting from tight supplies and low inventories,particularlyintheUnitedStates.

Thepriceofoilhasbeenhighand relativelystable over the past year.between July 2012 andJune2013 theaveragepriceforbrent/Dubai/West

Chart 1.2

MONThLy COMMODITy PRICE INDICES by COMMODITy GROUP, JAN. 2002–MAy 2013

(Index numbers, 2002 = 100)

Source: UNCTAD secretariat calculations, based on UNCTAD, Commodity Price Statistics Online database.

Note: Crude petroleum price is the average of Dubai/Brent/West Texas Intermediate, equally weighted. Index numbers are based on prices in current dollars, unless otherwise specified.

0

100

200

300

400

500

600

2002 2004 2006 2008 2010 2012

All commoditiesAll commodities (in euros)Minerals, ores and metalsCrude petroleum

0

100

200

300

400

2002 2004 2006 2008 2010 2012

FoodTropical beveragesVegetable oilseeds and oilsAgricultural raw materials

2013

2013

Current Trends and Challenges in the World Economy 9

Table 1.3

wORLD PRIMARy COMMODITy PRICES, 2007–2013(Percentage change over previous year, unless otherwise indicated)

Commodity groups 2007 2008 2009 2010 2011 2012 2013a

2011–2013 versus

2003–2008b

All commoditiesc 13.0 24.0 -16.9 20.4 17.9 -8.4 -3.3 68.6All commodities (in SDRs)c 8.6 19.5 -14.5 21.7 14.1 -5.5 -2.2 63.9All food 13.3 39.2 -8.5 7.4 17.8 -1.4 -4.3 77.0

Food and tropical beverages 8.6 40.4 -5.4 5.6 16.5 -0.4 -3.3 78.1Tropical beverages 10.4 20.2 1.9 17.5 26.8 -21.5 -13.5 77.9

Coffee 12.5 15.4 -6.9 27.3 42.9 -25.7 -16.2 96.9Cocoa 22.6 32.2 11.9 8.5 -4.9 -19.7 -5.8 42.9Tea -12.3 27.2 16.5 -1.0 11.4 0.8 -14.2 52.8

Food 8.5 42.5 -6.0 4.4 15.4 2.0 -2.4 78.2Sugar -31.7 26.9 41.8 17.3 22.2 -17.1 -15.5 121.5Beef 1.9 2.6 -1.2 27.5 20.0 2.6 1.4 63.4Maize 38.2 34.0 -24.4 13.2 50.1 2.6 -0.5 112.5Wheat 34.3 27.5 -31.4 3.3 35.1 -0.1 0.8 53.9Rice 9.5 110.7 -15.8 -11.5 5.9 5.1 -2.9 64.0Bananas -0.9 24.6 0.7 3.7 10.8 0.9 -6.2 58.2

Vegetable oilseeds and oils 52.9 31.9 -28.4 22.7 27.2 -7.6 -11.4 69.5Soybeans 43.0 36.1 -16.6 3.1 20.2 9.4 -6.4 67.4

Agricultural raw materials 12.0 20.5 -17.5 38.3 28.1 -23.0 -5.3 70.3Hides and skins 4.5 -11.3 -30.0 60.5 14.0 1.4 3.4 22.8Cotton 10.2 12.8 -12.2 65.3 47.5 -41.8 2.2 87.2Tobacco 11.6 8.3 18.0 1.8 3.8 -3.9 2.0 45.9Rubber 9.5 16.9 -27.0 90.3 32.0 -30.5 -8.4 119.4Tropical logs 19.5 39.3 -20.6 1.8 13.8 -7.4 1.0 28.6

Minerals, ores and metals 12.8 6.2 -30.3 41.3 14.7 -14.1 -0.8 54.9Aluminium 2.7 -2.5 -35.3 30.5 10.4 -15.8 -4.0 1.1Phosphate rock 60.5 387.2 -64.8 1.1 50.3 0.5 -8.2 88.6Iron ore 77.4 26.8 -48.7 82.4 15.0 -23.4 10.1 26.6Tin 65.6 27.3 -26.7 50.4 28.0 -19.2 8.7 125.2Copper 5.9 -2.3 -26.3 47.0 17.1 -9.9 -3.9 70.2Nickel 53.5 -43.3 -30.6 48.9 5.0 -23.4 -5.9 -2.8Lead 100.2 -19.0 -17.7 25.0 11.8 -14.2 6.3 60.1Zinc -1.0 -42.2 -11.7 30.5 1.5 -11.2 0.4 5.6Gold 15.3 25.1 11.6 26.1 27.8 6.4 -6.6 184.6

Crude petroleumd 10.7 36.4 -36.3 28.0 31.4 1.0 -2.2 77.3

Memo item:Manufacturese 7.5 4.9 -5.6 1.9 10.3 -2.2 .. ..

Source: UNCTAD secretariat calculations, based on UNCTAD, Commodity Price Statistics Online; and United Nations Statistics Division (UNSD), Monthly Bulletin of Statistics, various issues.

Note: In current dollars unless otherwise specified.a Percentage change between the average for the period January to May 2013 and the average for 2012.b Percentage change between the 2003–2008 average and the 2011–2013 average.c Excluding crude petroleum. SDRs = special drawing rights.d Average of Brent, Dubai and West Texas Intermediate, equally weighted.e Unit value of exports of manufactured goods of developed countries.

Trade and Development Report, 201310

Texasintermediate(WTi)was$105.5perbarrel,withpricesfluctuatingbetween$99and$111perbarrel.UpwardpressureonoilpriceshasbeenrelatedtoadeclineinproductionbymembersoftheorganizationofthePetroleumexportingCountries(oPeC)inthelastquarterof2012,andtogeopoliticaltensionsinWestAsiawhichaffectedoilsupplies.bycontrast,downsidepressuresonoilpricesin2013havebeenmostly linked to increased production,mainly inNorthAmerica,aswellassluggishglobaldemandgrowth,particularlyinmembersoftheorganisationfor economic Co-operation and Development(oeCD).indeed,itisexpectedthatallofthegrowthindemandforoilin2013willcomefromnon-oeCDcountries,whiledemandmayactuallyfallinoeCDcountries.overall,itappearsthatnewsupplieswillprovide a buffer against supply shocks stemmingfromgeopoliticaltensions.However,someobserv-ersseeatightermarketwhenthedifferentoilgradesareconsidered:therecouldbeanabundantsupplyoflightandsweetcrudeoil,butnotofmediumandsourcrude.Pricesofoilandmetalsalsoincreasedinearly2013basedonexpectationsofimprovedglobaleco-nomicconditions.However,subsequently,metalpricesdeclinedoncemoredue to slowgrowthof demandandincreasingsupplies,aswellasrisinginventories.

Commodity prices also continue to be influ-encedby the activities offinancial investors.The

rebound in oil andmetal prices observed in thesecondhalfof2012mayhavebeenpartlyrelatedtothethirdroundofquantitativeeasingintheUnitedStates,withsomeoftheincreasedliquidityprobablybeingusedtoinvestincommodityfuturesmarkets.bymid-2013,indicationsthatthismonetarystimuluscouldbescaledback,togetherwithacreditsqueezeinChina, fuelled awave of sell-offs in commod-ityderivatives.Thus, inthesamewayasfinancialinvestorscontributedtoamplifyingtheincreasesincommoditypricesbybuyingcommodityderivativesover the past decade, the commodity sell-offs byfinancial investorsmaywellhavehadsome influ-enceon thedecline in commodityprices in2013.Forexample,datafrombarclays(2013)showthatcommodityassetsundermanagementfellby$27bil-lion inApril 2013.Moreover, according tomediareports,banksareexpectedtodownsizeorwithdrawfrom their commodity investment business due toincreasedregulatoryandcapitalcosts.

Thecommoditypricecorrectionsin2012and2013mightpointtoareversaloftherisingtrendinpriceswitnessedduringthefirstdecadeofthemil-lennium.ontheotherhand,theycouldmerelybeapauseinthattrend.Sectionbofchapteriiprovidesamoredetailedassessmentofthelikelyevolutionofcommoditypricesoveralongerterm.

b. The structural nature of the latest crisis

Therecurrenceofeconomiccrisesisoneofthebestestablishedfactsineconomichistory.However,notallcrisesaresimilar,nordotheyrequiresimilarpolicyresponses.Anaccurateassessmentofacrisismustdeterminewhetheritistheresultoftemporaryproblems,whichmaybe resolvedmainlyby self-correctingmechanisms,ormoresystemicproblems.inthefirstcase,thestatus quo antecanbeexpectedtoberestoredafteracertainperiodoftime.inthecaseofastructural(orsystemic)crisis,however,changesto the prevailing economic and social frameworkbecomenecessary.

Theanalysisintheprevioussectionhasrevealedthatneitherthedevelopedeconomies,northedevel-oping and transition economieshavebeen able toreturn to the rapid growth pace they experiencedbeforetheonsetofthelatestcrisis.Manypraisedthe“greenshoots”ofrenascentgrowthin2010,but,soonafter,theprospectofarapidreturntoa“normal”statefaded.Thenotionofwhatis“normal”itselfischang-ing,andseveralobserversarespeakingofa“newnormal”withregardtoeconomicperformancesthatcanbeexpectedindifferentcountriesandregions.Thisrefers,ingeneral,tolowergrowthrates,butalso,

Current Trends and Challenges in the World Economy 11

andmorefundamentally,tothechangingconditionsand driving forces behind that growth. Since, asthisReportargues,thefactorsthatunderpinnedthepre-crisiseconomicexpansionwereunsustainable,endogenous adjustmentmechanisms or automaticstabilizersarenotlikelytorestorethem.Moreover,relyingonsuchastrategywillnotsucceedinreturn-ingeconomiestotheirpreviousgrowthpattern,norisitdesirable.

Thereisincreasingrecognitionofthestructuralnature of the present crisis, as evidenced by thewidespread calls for structural reforms.However,identifying the kinds of reforms needed dependscritically on a correct diagnosis of the nature ofthestructuralproblems.Manyproponentsofstruc-turalreformsbelievetheirmaingoalsshouldbetoimprove competitiveness and restore the strengthand confidence of financialmarkets.These goalsaresupposedtobeachievedbyshort-termmeasuressuchas thecompressionof labourcostsandfiscalausterity.However,sofar,thisapproachhasdelivereddisappointingresults.otherproposalsincluderadicalmeasures,suchasmoreflexiblelabourmarkets,lowersocial security coverage and a smaller economicrolefortheState.However,noneoftheseproposedreformsarelikelytosolvethestructuralproblems,andmayevenaggravatethem,becausetheyappeartobebasedonaflaweddiagnosis.

1. An impossible return to the pre-crisis growth pattern

(a) Persistent employment problems

Fiveyearsaftertheonsetoftheglobalcrisis,employmentconditions remainprecarious inmostdeveloped countries.Unemployment rates grewpersistentlyintheeU,from7.2percentin2007to11percentinMay2013.intheUnitedStates,theopenunemploymentratedeclinedfromitspeakof10percentinlate2009/early2010to7.6percentinmid-2013,which is still historically high com-paredwithlessthan5percent in2007.However,openunemploymentrates,onlypartiallydepicttheemploymentsituation;iftheseratesareconsideredalongwith discouragedworkers, thosemarginallyattachedtothelabourforceandthoseemployedparttimeforeconomicreasons,thetotalrateoflabour

underutilizationwas14.3percentinJune2013.4inJapan,employmentindicatorshaveimprovedsignifi-cantly:unemploymentisdownto4.1percentinMay2013,afterexceeding5.5percentinmid-2009,andisthusheadingtowardsitspre-crisislowof3.5percent.5

inthedevelopedcountriesasawhole,thetotalnumberofemployeddeclined from510million in2007 to500million in2012; theemployment rate(definedasapercentageoftheworkingagepopula-tion) in these countries fell from68.8 per cent to66.6percent.6Hadthatratenotfallen,totalemploy-mentwould have reached 517million persons in2012,whichmeans that the employment deficitcausedbythecrisis(i.e.feweremployedpeoplethanexpected based on pre-crisis trends) amounted to17millionpersons.Thisjobsgapordeficitresultingfromthecrisishasbeenlargerandlongerlastingthaninanypreviouscrisisaffectingdevelopedcountriesoverthepastthreedecades(chart1.3).

openunemployment in developing countrieshasbeenquitedifferentsincetheonsetofthecrisiscomparedwiththepre-crisisperiod.Amongthelarg-estdevelopingandtransitioneconomies(thosethataremembersoftheG-20),onlyMexicoandSouthAfricahadhigherunemploymentratesattheendof2012 thanbefore thecrisis;all theothercountriesmanaged to reduce that rate.between 2007 and2012,130millionjobswerecreatedinthedevelopingcountries(excludingChinaandindia),sufficienttopreventanincreaseintheirjobsdeficit(chart1.3).Mostdevelopingcountries,however,continuetofacehugelong-standingemploymentproblems,includinglowparticipationratesinformalactivities,particu-larlyamongwomen,highyouthunemploymentandalargeproportionoflow-qualityjobs.

The discrepancies between developed anddevelopingcountrieswithregardtoemploymentgen-erationreflecttheirdifferentgrowthperformances.indevelopedcountries,thestrategyofcreatingjobsbyreducing(orallowingareductionof)realwageshasnotdeliveredtheexpectedresultsinthepresenceofslow,orinsomecasesnegative,outputgrowth.Suchwagepolicieshaveanadverseimpactonaggregatedemand,whichmakesprivatefirmslesswillingtoinvestandtohirenewworkers.Reducingthepriceof labour does not lead to the expected outcomeof equilibratingdemand and supplyon the labourmarket, because lowering the price of labour (therealwage)notonlyreducesthecostsofproducing

Trade and Development Report, 201312

goodsandservices,butalso thedemandfor thosegoodsandservices.Attemptstoovercomeemploy-mentproblemsbyloweringwagesandintroducinggreaterflexibilitytothelabourmarketareboundtofailbecausetheyignorethismacroeconomicinter-dependenceofdemandandsupply thatcauses thelabourmarkettofunctiondifferentlyfromatypicalgoodsmarket.Totheextentthatlowerunitlabourcostsinonecountrygiveproducersinthatcountryacompetitiveadvantageoninternationalmarkets,anyincreaseinemploymentasaresultofhigherexportswillbeattheexpenseofproductionandemploymentintheimportingcountries.

(b) Adjustments that do not adjust

in the current policy debate, there is broadagreementabout thegoalsbutnotabouthowbesttoachievethem,andsometimesthemeansappearto be confusedwith ends.Restoring growth andemployment levels, reducing public debt ratios,repairingbankingsystemsandre-establishingcreditflows are generally shared objectives.However,

disagreementonpriorities,ontheappropriatepolicytools,aswellasonthetimingandsequencing,leadsto quite different, and sometimesopposite, policyrecommendations.Forinstance,thedominantviewinmostdevelopedcountriesandinseveralinternationalorganizations,atleastsince2010,hasbeenthatfiscalconsolidationisaprerequisiteforsustainedgrowthbecause itwill bolster the confidence offinancialmarketsandpreventsovereigndefaults.indeed,thiswas adopted as amajor commitment at theG-20summitinTorontoinJune2010.Thoseopposedtothisshifttowardsfiscalausterityseefiscalconsoli-dationasalong-termgoalwhichwouldbeachievedthroughsustainedgrowth,andnotasapreconditionforgrowth.inthisview,prematurefiscaltighteningwillnotonlybeverycostlyineconomicandsocialterms;itwillalsobecounterproductive,because,withslowergrowth,fiscalrevenueswillbelower,andthepublic-debt-to-GDPratio isunlikely todecline,ormayevenrisefurther(see,forinstance,TDR 2011,chap.iii;Krugman,2012;Calcagno,2012).

TheimpactofachangeinpublicrevenueandinspendingonGDP(i.e.thevalueoffiscalmultipliers)

Chart 1.3

ChANGES IN TOTAL EMPLOyMENT AND EMPLOyMENT RATES IN developed And developing CounTRies, 2008–2012

Source: UNCTAD secretariat calculations, based on ILO, Key Indicators of the Labour Market (KILM) database; and UN-DESA, World Population Prospects: The 2012 Revision database.

Note: China and India are excluded because small variations in their estimates would significantly alter global outcomes.

-20

0

20

40

60

80

100

120

140

2008 2009 2010 2011 2012

A. Changes in total employment(Millions of persons)

Developing countries, excl. China and IndiaDeveloped countries

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

2008 2009 2010 2011 2012

B. Changes in employment rates(Per cent of the working age population)

Current Trends and Challenges in the World Economy 13

hasbeenstudiedextensively.Manyofthesestudies,includingbytheinternationalMonetaryFund(iMF,2010),suggest thatfiscalmultipliersarerelativelylow.Forexample,theeCbestimatesshort-termfis-calmultiplierstobegenerallylowerthan1,whichmeansthatthenegativeimpactonGDPgrowthofareductionofgovernmentspendingoranincreaseoftaxesoverthefirsttwoyearsissmallerthantheamount of that fiscal change.on the other hand,the long-termmultiplier of a spending cutwouldbepositive,meaningthattheleveloftheGDPthatwouldbeobtainedafteratransitoryperiodofmorethan10yearsfollowingafiscaltighteningwouldbehigherthanthelevelexpectedwithoutit.Thiswouldresultfromthereductionoflabourtaxesthatwouldbemadepossiblebyan improvedbudgetpositionresultingfromfiscalausterity;gainswouldbelargerif,inaddition,fiscalconsolidationalsoledtolowersovereign risk premiums (eCb,2012).7However,arecentstudybytheiMF(2012)foundthatfiscalmultipliers in times of economic depressionweremuchhigherthanthevaluesithadestimatedinprevi-ousreports.Thereasonisthatinaneconomywithahugeamountofidleresources,anincreaseinpublicspendingdoes not involve any “crowdingout” ofprivateexpenditure.Thismeans thatexpansionaryfiscalpolicies are an important instrument to spurgrowthandactuallyreducethepublic-debt-to-GDPratio.However,theiMFrecommendationdoesnotgosofarastorecommendsuchpolicies;itmerelyrecommends undertaking fiscal adjustment overa longer time span. it suggests that policymakersshoulddeterminethepaceoffiscaladjustmenttak-ing intoaccountnotonly thevaluesofshort-termfiscalmultipliersanddebt-to-GDPratios,butalsothestrengthofprivatedemandandthecredibilityoffiscalconsolidationplans(blanchardandleigh,2013).

A set of estimates of fiscalmultipliers arepresentedintable1.4basedontheUnitedNationsGlobalPolicyModel.evenifonlytheeffectsofanincreaseinfiscalexpenditureduringthefirstyearareconsidered,theresultsstronglysupportthehypoth-esisofhighmultipliers,whichsignificantlyexceed1inallthecases,andarefrequentlygreaterthan1.5.ontheotherhand,multipliersassociatedwithchangesintaxationaremuchlower,inallcasesbelow0.5inabsolutevalues.8Thismeans that the compositionofafiscalpackagemaybeatleastasimportantasitssize.inparticular,itwouldbepossibletodesignfiscal packages comprising both higher taxes andexpenditure,whichwouldthereforehaveaneutral

ex-anteeffectonthefiscalbalance,butstillapositiveimpactongrowth.Thisinturnwouldenlargethetaxbaseandwouldeventuallydeliverapositiveex-posteffectonthefiscalbalanceandthepublic-debt-to-GDPratio.butgiventhehighvaluesofgovernmentspendingmultipliers,itislikelythatadebt-financedincreaseinfiscalexpenditurewouldgenerateenoughgrowthandsupplementaryfiscalrevenuestoreducethatratio.9Asshownintheannextothischapter,thiseffectwouldbe even stronger if several countriespursuedexpansionarypoliciessimultaneously.

Despite growing evidence that fiscal auster-ity hampersGDPgrowth,many governments areunwillingtochangethisstrategyastheybelievetheydonothaveenoughpolicyspaceforreversingtheirfiscal policy stance;10 instead, they are relying onmonetarypolicyforsupportinggrowthandemploy-ment.However, there is little scope formonetary

Table 1.4

ShORT-TERM FISCAL MULTIPLIERS

Government spending on goods and services

Government taxes net of

transfers and subsidies

Argentina 1.66 -0.36Brazil 1.84 -0.37Canada 1.51 -0.27China 1.76 -0.42CIS 1.54 -0.33France 1.48 -0.27Germany 1.38 -0.29India 1.65 -0.41Indonesia 1.64 -0.41Italy 1.48 -0.31Japan 1.35 -0.29Mexico 1.59 -0.36South Africa 1.68 -0.31Turkey 1.71 -0.39United Kingdom 1.32 -0.26United States 1.58 -0.36

Source: UNCTAD secretariat estimates, based on United Nations Global Policy Model (see the annex to this chapter).

Note: Multiplier values represent first-year impact on GDP of one-unit ex-ante increases in government spending or government revenues (i.e. taxes net of transfers and subsidies).

Trade and Development Report, 201314

policytofurtherreduceinterestratesindevelopedeconomies,as thesearealreadyextremely low. inaddition, so far,unconventionalmonetarypolicies(i.e.quantitativemonetaryexpansion)havefailedtorevivecredittotheprivatesector.banksandotherfinancial institutions that have access to liquiditywillnotautomaticallyincreasetheirsupplyofcreditcommensurately,astheymaystillhavetoconsoli-datetheirbalancesheets.Moreover,eveniftheydidexpandtheircreditsupply,manyprivatefirmswouldbeunlikelytoborrowmoreaslongastheyhavetoconsolidate their ownbalance sheetswithout anyprospect of expandingproductionwhen they facestagnant,orevenfalling,demand.Thisiswhyusingmonetary policy for pulling an economyout of adepressiontriggeredbyafinancialcrisismaybelike“pushingintoastring”.

ontheotherhand,centralbankinterventions(orannouncementsoftheirintentions)haveprovedremarkablyeffectiveinloweringriskpremiumsonsovereigndebt.Thus,monetaryandfiscalpoliciesmaybeusedfordifferentpurposesfortacklingthecrisis.Fiscalpolicy,givenitsstrongpotentialimpacton aggregate demand, could be used to supportgrowthandemploymentinsteadoftryingtorestorethe confidence offinancialmarkets throughfiscalausterity.Meanwhile, central banks could enlargetheirroleaslendersoflastresort(llR)togeneratethatconfidenceandmaintaininterestratesatlowlev-els.Moreover,thesecentralbankactionstosupportcreditandgrowtharemorelikelytosucceediftheyareaccompaniedbyanexpansionaryfiscalpolicy.

2. Roots of the crisis: the build-up of structural problems

Sincethelate1970sandearly1980spoliciesbasedonsupply-sideeconomics,neoliberalismandfinance-ledglobalizationhaveinvolvedaredefinitionoftheroleoftheStateintheeconomyanditsregula-torytasks;anextraordinaryexpansionoftheroleoffinanceat thenationaland international levels;anopeningupofeconomies,includingareductionoftradetariffs;andageneralincreaseininequalityofincomedistribution.Theresultingnewrolesofthepublic,privateandexternalsectors, theexpansionoffinanceandtheincreasingincomeconcentrationalteredthestructureanddynamicsofglobaldemandinawaythatheightenedvulnerabilities,eventually

leadingtothecrisis.inotherwords,thepresentcrisiswasnot theunfortunate result of somemisguidedfinancialdecisions;rather,itwastheculminationofanumberofstructuralproblemsthathavebeenbuild-ingupoverthepastthreedecades,whichcreatedtheconditionsforgreatereconomicinstability.

(a) Income inequality

inordertoachievesustainedglobalgrowthanddevelopment, therehas tobeconsistentgrowthofhouseholdincome,thelargestcomponentofwhichis labour incomeobtained from theproductionofgoodsandservices.11However,overthepastthreedecades, labourincomeintheworldeconomyhasbeengrowingataslowerpace than thegrowthofworldoutput(chart1.4),withsomedivergingtrendsoverthepastdecade.12

Theobserveddecliningtrendsintheshareoflabour income–orwageshare–haveoftenbeenjustifiedasbeingnecessaryinordertoreducecostsand induce investment. However, wage income

Chart 1.4

ShARE OF wORLD LAbOUR INCOME IN woRld gRoss ouTpuT, 1980–2011

(Weighted averages, per cent)

Source: UNCTAD secretariat calculations, using UN Global Policy Model, based on UN-DESA, National Accounts Main Aggregates database; and ILO, Global Wage database.

Note: Mixed income, typically from self-employment, is included in the labour share.

52

54

56

58

60

62

64

1980 1985 1990 1995 2000 2005 2011

Current Trends and Challenges in the World Economy 15

constitutesalargeproportionoftotalincome(abouttwothirdsindevelopedcountries),andisthereforethemostimportantsourceofdemandforgoodsandservices.Thus,sizeablereductionsofsuchincomerelative to productivity gainswill have tangiblenegativeeffectsontherateofhouseholdconsump-tion.And,totheextentthatproductiveinvestmentisdrivenbyexpectationsofexpandingdemand,second-roundeffectsoflowerconsumptiononinvestmentwouldseemunavoidable.

Thedeclineintheshareoflabourincomehasledtoarisingtrendofprofitmark-upsintheworldasawhole.Thetendencyofcompaniestoseekprofitgainsfromexploitingwagedifferentials,ratherthanthrough innovation and investment, has producedlimiteddynamicbenefitsfor therestofsociety.inotherwords, the presumed transmission of higherprofits to higher grossfixed capital formationhasnotmaterialized.13

inadditiontothesenegativeeffectsonlong-termgrowth,greaterincomeinequalityalsocontributedtothefinancialcrisis.Thelinksbetweenexpandingfinanceandrisinginequalityoperatedintwoways.Thelargersizeandroleplayedbythefinancialsec-tor ledtoagreaterconcentrationof incomeinthehandsofrentiers (bothequityholdersand interestearners)andafewhigh-wageearners,especiallyinthefinancialsector.Concomitantly,greaterinequalityledtorisingdemandforcredit,bothfromhouseholdswhosecurrentincomewasinsufficienttocovertheirconsumptionandhousingneedsandfromfirmsthatdistributedadisproportionateshareoftheirprofitstotheirshareholders(TDR 2012,chap.ii).Thisledtoafinancialbubblethateventuallyburst,leavingmanyhouseholds,firmsandbanksinfinancialdistress.

(b) Smaller role for the State

Another long-running trend since the early1980s has been the diminishing economic role oftheStateinmanycountriesbywayofprivatization,deregulationand lowerpublicexpenditure (on thelatter,seesectionCofthischapterandtable1.7).Thisservedtoincreaseeconomicfragilityindifferentways.

Whenthepublicsector’sshareofGDPshrinks,economic vulnerability increases because of thatsector’sdiminishedcapacitytocompensatefortheusualfluctuationsinthebusinesscycleandtocope

withsignificantcrises.14butevenmorerelevantthangovernments’abilitytointervene,istheirwillingnesstoconductcountercyclicalpoliciesatatimewhenthedesirabilityforbalancedfiscalbudgetshasbecomedogma(Galbraith,2008).

Callsforbalancingbudgetsfrequentlyoverlookthefactthatoneeconomicsector’sdeficitisneces-sarilyanothersector’ssurplus.Therefore,areduction(orincrease)inthepublicsectordeficitshowsupaseitherareduction(orincrease)intheprivatesectorsurplus,orareduction(orincrease)inthesurplusoftherestoftheworld,oracombinationofthesetwo.Fortheworldasawhole,wheretheexternalsectoris,bydefinition,inbalance,publicandprivatesectorsmirroreachother.Thiscanbeillustratedbytheevolu-tionofpublicandprivatesectorbalancesatthegloballevelbetween1971and2011(chart1.5).Asthischartshowsaggregatevalues,itmainlyreflectswhathap-penedinthelargestcountries.itappearsthatbetweenthemid-1970sand1990,therewasapersistentandrather stablepublicdeficit (andprivate surplus)ataround3.5percentofglobaloutput.Thisinitselfdidnotposeaproblem:itisnormalfortheprivatesectortorunsurpluses,sinceitsassumedobjectiveiswealthaccumulation.Andthatlevelofpublicdeficitwouldnotleadtoanyexplosiveaccumulationofpublicdebtstocks;onthecontrary,itwouldbeconsistentwithastabledebt-outputratioif,atthesametime,nominaloutputweretogrowsufficiently.15

This contrastswith the considerable instabil-ityobservedsincethebeginningofthe1990s.itisnoteworthythatperiodsofshrinkingpublicdeficitsactually precededmajor crises in 2001 and2008.itwas possible to cut public deficits because theprivate sectorwas reducing its savings andmanyprivateagentsbecamehighlyindebtedinthewakeofunsustainablefinancialbubbles.Pressurestoreducefiscaldeficitscanbedestabilizingtotheextentthatthosedeficitsaremirroredbyshrinkingprivatesectorsurpluses.indeed,theyarepartlyresponsibleforthegreaterfrequencyoffinancialcrises.

Anotherfactorcontributingtothosecrisessincethe1980shasbeenwidespreadfinancialliberaliza-tion,whichisanothermajoraspectofthereducedeconomic roleof theState.Financialderegulation,coupledwiththeextraordinaryexpansionoffinancialassets,allowedmacroeconomicpolicieslimitedroomformanoeuvre,andtheireffectscametobeincreas-ingly swayed by reactions on financialmarkets.

Trade and Development Report, 201316

Moreover,astheaccessofgovernmentstocentralbank financingwas limited, the financial sectorgainedgreaterinfluenceoverpolicymakers.

Thisinteractionbetweendevelopmentsinthefinancialsector,togetherwiththeweakeningofgov-ernmentandcentralbankinfluenceontheeconomy,generates a particular problemwhen a recessiondoesnotresultfromcyclesintherealsectoroftheeconomy,butinsteadfromoverindebtednessoftheprivatesectorasawhole.Koo(2013a)describesthistypeofrecessionasfollows:“Whenadebt-financedassetpricebubblebursts,theprivatesectorisleftwithahugedebtoverhang,andtoclimboutofthisstateofnegativeequityitmustpaydowndebtorincreasesav-ings,evenifinterestratesarezero.Whentheprivatesectorasawholeisminimizingdebt,theeconomycontinuouslylosesaggregatedemandequivalentto

thesavedbutunborrowedamount.Thissituationhascometobeknownasabalancesheetrecession.”insuchasituation,thechoiceisbetweenaprolongedrecessionandapublic-deficit-financedrecovery.Astheprivatesectortakesalongtimetoreduceitsdebt,additionalborrowingbythepublicsectorwouldbetheonlyrecourse.AsnotedbyKoo(2013b),“theonlywaytokeepboththeGDPandmoneysupplyfromshrinkingisforthegovernment–thelastborrowerstanding–tostepinandborrowtheunborrowedsav-ingsandspendthemintheprivatesector.”16

At the same time,however,governments arereluctanttoincreasetheirdebtforfearofnegativereactionsfromthefinancialmarketsandfrompublicopinion,muchofwhichhasbeengiventounderstandthatfinancialmarkets “knowbetter” thangovern-ments(Koo,2013a).

Chart 1.5

FINANCIAL POSITIONS OF PUbLIC AND PRIVATE SECTORS IN ThE wORLD ECONOMy, 1971–2011

(Per cent of world domestic product)

Source: UNCTAD secretariat calculations, using UN Global Policy Model, based on UN-DESA, National Accounts Main Aggregates database; IMF, Government Financial Statistics; Eurostat; and national sources.

Note: Figures above zero denote a surplus and below zero a deficit. Surpluses indicate additions to the net stock of financial wealth, and deficits indicate additions to the stock of debt. Except for small errors of measurement and aggregation of large numbers, the surpluses and deficits mirror each other.

-6

-4

-2

0

2

4

6

1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011

Public sector

Private sector

Current Trends and Challenges in the World Economy 17

(c) The prominent role of a poorly regulated financial sector

Thevalueofglobalfinancialassetsgrewfrom$14 trillion in 1980 to $56 trillion in 1990 and$206trillionin2007;andincurrentGDPtermsittri-pled,from120percentofGDPin1980to365percentin2007(lundetal.,2013:14).Thisexpansionwasaccompanied(andencouraged)byextensivederegula-tionofnationalfinancialmarketsandtheprogressiveliberalization of international capitalmovements.Asaresult,cross-bordercapitalflowsjumpedfrom$500billionin1980toapeakof$12trillionin2007.Thiswouldexplainwhyanincreasingproportionoffinancialassetsareownedbynon-residents.between1980and1995, the stockof foreign-ownedfinan-cialassetsrepresentedaround25percentofglobalfinancialassets.Thisshareincreasedto28percentin2000,38percentin2005andalmost50percentin2007–2010,whenforeign-ownedassetsexceeded$100trillion,or150percentofworldoutput.

Thismore prominent role of financialmar-ketscarriestheriskofgreatereconomicinstability,becausethesemarketsareintrinsicallypronetoboom-and-bust processes, especially if they are looselyregulated.Atypicalprocessbeginswithrisingpricesoffinancial andnon-financial assets,whichboostwealthtemporarilyandserveascollateralfornewcreditsorequitywithdrawals.Thisinturnfinancesprivate spending and also new asset acquisitions,whichpushupassetpricesfurther.Thisprocesscancontinueforarelativelylongtime,whichsustainseconomicgrowthand thushelpsenhance investorconfidence.However,eventuallytheassetpricebub-blethathadsustainedacredit-boomexpansionwillburst,leadingtoadrasticandlong-lastingcontractionofeconomicactivity.

This portraysmany historical episodes of“manias,panicsandcrashes”(Kindleberger,1978),includingthebubblethattriggeredthepresentcrisis.itisindeedsurprisingthat,asthebubblegrew,someworryingsignalsweredismissedbypolicymakersaswellasratingagenciesandfinancialagentsbecause,although household debtwas rising, the value ofhouseholdassetswasalsorising(bernanke,2005).17Duetoanexclusivefocusonmonetarystabilitytheearlysignalsoffinancialinstabilitywentunheeded.

According to someobservers,monetary pol-icy that focuses exclusivelyon low inflation rates

contributestothecreditcycle(Godley,1999;Shin,2010).Usually, lowor falling interest rates reflectlowcurrent or expected inflation.Thismay allowtheburdenofthedebtservicetofallorremainlowdespitearisingstockofdebt.butassoonaspercep-tionsofriskchange,interestratepremiumsrise.Theburdenof servicing debts thatwere contracted atflexibleinterestratesorthecostsofrevolvingdebtthatisreachingmaturityrise,sometimesdrastically.inaddition,adrasticreversalofcreditdemandand,byimplication,ofspending,maytriggeraneconomicdownturn thatwouldmakedebt repaymentsmoredifficult.

The extraordinary expansion of thefinancialsectorovertheyearshasalsobeenaccompaniedbychangesinitspatternsofoperation,whichcontributedtoanincreaseinfinancialfragility.Theseincludeda high level offinancial leveraging, an increasingrelianceonshort-termborrowingforbankfunding,theextensionofapoorlycapitalizedandunregulatedshadowfinancial system, perverse incentives thatencouragedexcessiverisk-takingbyfinancialtraders,arelianceonflawedpricingmodelsandthe“lendanddistribute”behaviourthatweakenedtheroleofbanksindiscriminatingbetweengoodandbadborrowers.Theprocyclicalbiasofbankcreditwasexacerbatedbyvalue-at-riskmodelsandthebaselrulesonbankcapital,whichallowedbankstoexpandcreditduringbooms,whenrisksseemedlowandthepriceofcol-lateralsrose,andobligedthemtocutlendingduringdownturns.Thevulnerabilityofthefinancialsystemalsoincreasedasaresultofitsgrowingconcentrationandlossofdiversity.Muchofitsoperationstodayarehandledby“too-big-to-fail” institutionswhichtendtotakeonfargreaterrisksthanwouldbetakenbysmallerinstitutions.Asthesametypeofbusinessstrategiestendedtobereplicatedacrossthefinancialsector,thesystembecamemorevulnerabletomacro-economicshocks(suchasthecollapseofrealestatemarkets)thataffectedalltheagentsatthesametime(seeTDR 2011,chap.iV).

Thesearchforrapidgainsledtolargeflowsofcredit–includingloansthatwereinsufficientlycollat-eralized–thatwereusedforconsumption,ratherthanforfinancingproductiveinvestmentandinnovativeenterprise.Thiskindofcredit-fuelledspendingbytheprivatesectorhadthepotentialtooffsetthesub-dueddemandthatwascausedbylaggingwagesandworseningincomedistribution.However,debt-drivenconsumptionisnotaviableoptioninthelongrun.

Trade and Development Report, 201318

itispossiblethatsomeofthecharacteristicsofthecreditboomindevelopedcountriesarebeingrep-licatedindevelopingcountries,withsomevariations.Assetappreciationsandprivatespendingthatexceedsincomeareoftensupportedbycapitalinflows,usuallychannelled throughdomesticfinancial institutions.in such cases, currencymismatches betweendebtandrevenuetendtogenerateorreinforcethecreditboom-and-bustcycle.

Throughthesedifferentchannels,thegrowingsizeand roleof thefinancial sector, togetherwithitspresentstructureandmodesoffunctioning,havebecomeamajorsourceofeconomicinstabilityandmisallocationofresourcesinmanycountries.ithasalsofacilitatedtheriseofinternationalimbalances,anotherkeystructuralproblemthatisexaminedinthenextsubsection.

(d) International imbalances with asymmetric adjustments and a recessionary bias

increasing current account imbalances andthe expansion of international finance are closelyintertwined.intheimmediatepost-warera,thereareunlikely tohavebeenanycountries thathadlargeexternaldeficits forextendedperiodsof time.butsuchdeficitshavebecomemoreandmorecommonintheeraoffinancializationthatstartedinthe1980sanddeepenedfromthe1990sonwards.

large surplus and deficit imbalances in theworld economy from themid-1970s to the early1980sweremostly due to oil shocks (chart 1.6).Theseshockscontributedtotheexpansionofinter-nationalfinancialmarketsthroughtherecyclingofpetrodollars.However,theimbalanceswereconsid-ered temporary, as itwas assumed that oil-deficitcountrieswoulddevisestrategiestoreducetheiroil-importbills.bycontrast,inthemiddleofthe1980stheUnitedStates had an external deficit of about3percentofGDPwhichwasunrelatedtooil.ThiswasmatchedbysurplusesinJapanandafewWesterneuropeancountries,whichtookconcertedcorrectiveaction in1985.The smoothcorrectionof externalimbalances that followed could be considered thelasttimetherewasproactiveinternationalcoordina-tioninthemanagementoftradeandexchangerates.butitmayalsoserveasalessonaboutthelimitsofa framework for policy coordination that focuses

exclusivelyonexchangerateswhiledisregardingthegrowinginstabilityoftheglobalfinancialsystemasawholeinviewofsubsequentdevelopments.

bytheendofthe1990s,atendencytowardsris-ingglobalimbalancesre-emerged,owinglargelytocurrentaccountdeficitsinafewdevelopedcountrieswherecredit-drivenexpansionbecameprevalent,asdescribedintheprevioussubsection.Thistendencywasreinforcedbytheadoptionofexport-ledstrate-giesbydeveloped-countryexportersofmanufactures,suchasJapanandafewNortheuropeancountries,followedbyGermany.Duringthe1990s,andmoreclearlyaftertheAsianfinancialcrisis,anumberofdeveloping countries that emerged as suppliers oflow-costmanufactures generated growing exter-nal surpluses.others that also sustained surplusesincludednetexportersofenergyandrawmaterials,especiallyduringthe2000swhencommoditypricesturned favourable.These factors together causedglobalcurrentaccountimbalancestopeakin2006atnearly3percentofworldincome.Thereversalthatfollowedfrom2007onwardscoincidedwiththefirst signsoffinancial turmoil in themajordeficitcountry,theUnitedStates,andculminatedwiththefinancial and economic crisis in 2008–2009.Thishighlightedthelimitationsoftheasset-appreciation,credit-drivenmodeldiscussedabove.Globalimbal-anceshaveremainedatabout2percentsince2009–alevelthatisstillhistoricallyhigh.Furthermore,globalimbalanceshavebeenontherisesince2009.

export-ledgrowthstrategies,totheextentthattheyhavefrequentlyledtotradesurpluses,areonlysustainableifothercountriesmaintaintradedeficitsoveralongperiod.inshort,thesuccessofsuchstrate-giesinsomecountriesreliesonexternaldeficitsinothercountries,andthewillingnessandcapacityofthedeficitcountriestopileupexternaldebt.butsincethecrisis,developedcountrieswithdeficitsseemtobe lesswillingandable toplay the roleofglobalconsumeroflastresortduetotheirever-increasingindebtedness.Despite this, policymakers in somecountriesaretryingtorespondtoweakerdomesticdemandby gaining exportmarket shares throughimprovedinternationalcompetitiveness.Thisispar-ticularlythecasewiththosecrisis-hitcountriesthatwererunninglargecurrentaccountdeficitsbeforethecrisisandhaveundertakenrecessionaryadjustmentsprogrammes.Themostcommonmeasureadopted,atleastintheshortrun,hasbeeninternaldevaluation,particularly throughwage compression.However,

Current Trends and Challenges in the World Economy 19

thissimultaneouslyactionbyseveraltradepartnerscontributestoaglobalcompressionofincomeandreinforcesa race to thebottom.Thisnotonlyhasnegativeeffectsonglobalaggregatedemand,sincea country’s lowerwage bill constitutes a demandconstraintthataffectsothercountriesaswell,butitalsounderminestheireffortstogaincompetitiveness(Capaldoandizurieta,2013).

Aglobalmechanismtohelprebalanceexternaldemandwillnotbeeffectiveifitplacestheentireormostoftheburdenofadjustmentondeficitcountries.Suchanasymmetricadjustmentisdeflationary,sincedebtor countries are forced to cut spendingwhilethereisnoobligationonthepartofcreditorcountriesto increasespending,which leads toashortfallofdemandatthegloballevel.itwouldbepreferable,fromaneconomicandsocialpointofview,ifsurpluscountriesassumedagreaterroleintherebalancingprocessbyexpandingtheirdomesticdemand.ideally,anasymmetricexpansionaryapproachwouldbethe

mosteffectivewaytorestartglobaloutputgrowthonasustainablebasis.insuchanapproach,theadjust-ment burdenwould be taken on primarily by thesurpluscountriesbywayofstrongerwageincreasesandfiscalexpansion.

inordertoexploretheglobalconsequencesofthesealternativeapproaches,theannextothischapterpresentsthreesimulationsshowingtheoutcomesofalternative policy strategies.They are quantitativeexercisesbasedontheUnitedNationsGlobalPolicyModel.Theseexercisesshowtheperformanceoftheworldeconomydividedinto25countriesorgroupsofcountriesatthehorizon2030basedontwoalter-nativescenariosinadditiontothebaselinescenario.The baseline scenario is an economic projectionassumingthattherewillbeneitherpolicychangesnorshocksahead.bothalternativescenariosinvolvethe followingpolicychangesaimedat stimulatingthe economy: expansionary fiscal policies,withhigherpublicconsumptionandinvestmentspending;

Chart 1.6

CONTRIbUTIONS TO GLObAL IMbALANCES OF SELECTED GROUPS OF COUNTRIES, 1970–2011(Current account balance as a percentage of world gross product)

Source: UNCTAD secretariat calculations, based on UN-DESA, National Accounts Main Aggregates database; IMF, World Economic Outlook (WEO) database.

Note: Deficit and surplus classification was based on the average current account (CA) position between 2004 and 2007. CIS includes Georgia.

-3

-2

-1

0

1

2

3

1970 1975 1980 1985 1990 1995 2000 2005 2010

Oil-exporting economies

CA deficit developing economiesCA surplus developing economies, excl. ChinaCA deficit developed economiesCA surplus developed economies China

CIS

2011

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progressive income redistribution through awagepolicy,taxationandpublictransfers;andasupportivemonetarypolicyin termsof lowinterestratesandgreateraccesstocredit,whileavoidingthecreationoffinancialbubbles.Surpluscountriesareassumedtoapplyastrongerstimulusthandeficitcountries,butnocountryissupposedtoadoptacontractionarypolicystance.ThedifferencebetweenthesetwoalternativescenariosisthatinscenarioA,all countriesimple-mentpolicychangesthataremoreorlessambitiousdependingontheirstartingposition,whereasinsce-nariob,only developing and transition economiesadopt suchpolicychanges. inaddition, thepolicystimulusinscenariobissmallerduetobalance-of-paymentsconstraintsresultingfromnon-actiononthepartofdevelopedcountries.

ScenarioA, which includes a generalizedstimulus,achievesnotonlyasubstantialreductionofglobalimbalances,butalsothebestresultsintermsofeconomicgrowth,employmentcreationandfiscalbalancesinallthecountries.Thisisinlinewiththeviewthatthebestapproachtoresolvingthepresenteconomicproblems,includingonthefiscalside,isifallcountriessimultaneouslyadoptexpansionarypoli-cies,takingintoaccounttheirrespectivecapacities,ratherthanadoptinggeneralizedausterity.

Scenariob,inwhichonlydevelopingandtran-sitioneconomiesapplymoreexpansionarypolicies,yieldsinferioreconomicresults,thoughstillclearlybetterresultsthanthoseofthebaseline.Thisisespe-ciallytruefordevelopingandtransitioneconomies.expansionarypoliciespursuedbythemmaycom-pensateforprotractedslowgrowthofexportstothedevelopedcountries.Alsodevelopedcountriesobtainsomebenefits in this scenario comparedwith thebaselinescenario,eveniftheseareminor.butthese

mostlystemfromthefactthat,insteadofcoordinat-ingeffortstowardsagenuineglobalrebalancingandaccelerationofgrowth,thedevelopedcountrieswillpressaheadwithindividualpoliciestowardsachiev-ing external competitiveness by squeezing labourincome.Theirgainsthereforeresultfromenlargingtheir share in global demand.What ismore, suchgainswillnotbeevenlydistributedbetweenwage-earnersandprofit-earnersinthesecountries.Finally,suchpracticeswillnothelptorebalancetheworldeconomy.

These exercises are not forecasts, since theirhypothesis of extensivepolicy changes arehighlyunlikelytooccur.Rather,theyarequantitativeexer-cisesthatareintendedtoevaluatetheconsistencyandeconomicfeasibilityofcoordinatedpoliciesaimedatspurringgrowthandemploymentbyaddressingthestructuralcausesofthecrisis,suchasincomeinequal-ity, thediminishing roleof theStateandfinancialsystemsthatdonotsupporttherealeconomy,andatcorrectingthepresentasymmetricanddeflationaryapproachtoglobalimbalances.

Thesimulationsalsoshowthatageneralshifttowardsexpansionarypoliciesiseconomicallyfea-sible,andwoulddeliverbetterresultsinallrespectsthanthebaselinescenario.Thissupportstheviewthatallcountriesshouldengageinacoordinatedeffortaimedatasustainedexpansionofglobaldemand.This exercise also shows that even if developedcountriesperseverewiththeircurrentpolicies,thereis,nevertheless,scopefordevelopingandtransitioneconomiestoimprovetheireconomicperformancesby providing a coordinated economic stimulus.Hence,encouragingregionalcooperationandSouth-Southtradewouldneedtobeanimportantcomponentoftheirdevelopmentstrategies.

Current Trends and Challenges in the World Economy 21

Theshapeoftheworldeconomyhaschangedsignificantlyoverthepastthreedecades.TheshareofdevelopingcountriesinglobalGDPhasincreased,andseveraldevelopingcountriesandregionshaveassumedagreaterroleasadditionaldriversofglobaleconomicgrowth.otherelementsofthisriseoftheSouthincludethegrowingimportanceofdevelop-ingcountriesininternationaltradeandcapitalflows.This section startswith an account of developingcountries’growthrecordoverthepastthreedecades,andgoesontodiscusssomeissuesrelatedtotheirincreased tradeandfinancial integration. it arguesthat,whilegreaterintegrationsupportedtheirrapidgrowthwhenthegeneralexternaleconomicenviron-mentwas favourable,with that environment nowturning less favourable, it has also increased theirvulnerability.

1. Growth performance since the early 1990s

The1990sandthebeginningofthenewmillen-niumsawaseriesofpaymentsandfinancialcrisesindevelopingcountries,includinginMexicoin1994,insomepartsofAsiain1997–1998–withspilloverstobrazilandtheRussianFederationin2008–inTurkeyin2000–2001andinArgentinain2001–2002.inspiteof thesecrises, developingcountries registeredanaverageannualGDPgrowthof4.7percentduringtheperiod1991–2002,exceedingthatofdevelopedcountriesbyovertwopercentagepoints(table1.5).Meanwhile,averageannualGDPgrowthofthetran-sitioneconomiesdeclinedby2.6percent, largelyas a resultof their economiccollapse in theearly1990s.Developing countries’ growthperformance

duringtheperiod1991–2002wassuperiortothatofdevelopedcountriesforanumberofreasons.onewastheirreboundfromeconomicdownturnsrelatedtodebtcrisesthatmanyofthemhadexperiencedinthe1980salongwithsharpdeclinesincommodityprices.Anotherwas themixedperformanceofdevelopedcountries,withaprotractedperiodofslowgrowthinJapan,unevengrowthineurope,andasharpgrowthdecelerationintheUnitedStates,whichwasassoci-atedwiththeburstingofthedot-combubblein2001.

During theperiod2003–2007,outputgrowthindevelopingandtransitioneconomiesaccelerated,evenasdevelopedcountriescontinuedtoexperiencerelatively slow growth, on average.The averageannualGDPgrowthofbothdevelopingandtransi-tioneconomiesexceededthatofdevelopedcountriesby 4.5–5 percentage points (table 1.5).The onsetoftheglobaleconomicandfinancialcrisisinitiallyreinforcedthistrend,asthedownturnin2008–2009waslessdramaticandthesubsequentrecoverymorerapidindevelopingthanindevelopedcountries.Thisgrowthdifferentialinfavourofdevelopingcountrieswasunprecedented (Akyüz,2012), even though itsubsequentlyshrankovertheperiod2010–2012.

Growth accelerationduring2003–2007 com-paredwith the period 1991–2002 has divergedconsiderably across developing countries. itwasparticularlypronouncedinsomeofthelargedevel-opingandtransitioneconomies,suchasArgentina,india, theRussian Federation, SouthAfrica andTurkey, butmuch less so in brazil, China andMexico.TheRepublicofKoreaevenrecordedloweraverageannualgrowthrates.Thesharpincreaseinthose rates inArgentina, theRussian FederationandTurkeywaspartlyduetothesecountries’swiftrecoveryfromseverecrisesatthebeginningofthe

C. Developing and transition economies are continuing to grow, but remain vulnerable

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millennium,whichhadcausedlargeoutputlosses.in2011–2012growthperformancegraduallyworsenedinalldevelopingregions,aswellasinmostcountriesindividually(table1.5),especiallyinbrazil,indiaandTurkey.Nevertheless,evenintheselattercountries,per capita income continues to exceed pre-crisislevelsbyasignificantmargin.ThisindicatesthattheadoptionofcountercyclicalmacroeconomicpoliciesenabledmanydevelopingcountriestomitigatetheimpactoftheGreatRecessionontheireconomiesforacertainperiodoftime.However,themorerecentworseningoftheirgrowthperformancesuggeststhatthe growth stimulus effects of their expansionarypoliciesmaybepeteringout.

Despitethehealthygrowthindevelopingandtransitioneconomies,developedcountriesremainedthemaindriversofglobalgrowthuntiltheonsetofthecurrentcrisis.Duringtheperiod1990–2005,theselattercountriesaccountedforaboutthreequartersofglobalGDP(table1.6),andtheshareoftheircontri-butiontoglobaleconomicgrowthexceeded50percent.bycontrast,duringtheperiod2008–2012,asagrouptheycontributedverylittletoglobalgrowth(table 1.5). Since 2010, global growth has beendrivenmainlybydevelopingcountries,whichhaveaccountedforabouttwothirdsofsuchgrowth,whilethe contribution of transition economies has beennegligible.

Table 1.5

COMPARATIVE OUTPUT GROwTh PERFORMANCE, SELECTED COUNTRIES AND COUNTRy GROUPS, 1991–2013

(Per cent)

1991–2002 2003–2007 2008–2012 2010 2011 2012 2013

Output growth (annual

average)

Contribu-tion to global growth

Output growth (annual

average)

Contribu-tion to global growth

Output growth (annual

average)

Contribu-tion to global growth Output growth

World 2.9 2.9 3.7 3.7 1.7 1.7 4.1 2.8 2.2 2.1

Developed economies 2.6 2.0 2.6 2.0 0.3 0.2 2.6 1.5 1.2 1.0

Transition economies -2.6 -0.1 7.6 0.2 1.8 0.0 4.5 4.5 3.0 2.7

Developing economies 4.7 0.8 7.0 1.5 5.3 1.4 7.9 5.9 4.6 4.7Africa 2.9 0.1 5.8 0.1 3.6 0.1 4.9 1.0 5.4 4.0East, South-East and South Asia 6.5 0.5 8.3 0.9 6.8 1.0 9.3 7.0 5.3 5.5West Asia 3.7 0.1 6.9 0.2 4.0 0.1 7.0 7.1 3.2 3.5Latin America and the Caribbean 2.9 0.2 4.8 0.3 3.0 0.2 5.9 4.3 3.0 3.1Oceania 2.2 0.0 3.1 0.0 3.4 0.0 3.6 4.3 4.1 2.7

Memo items:Argentina 2.6 0.0 8.9 0.0 5.8 0.0 9.2 8.9 1.9 4.8Brazil 2.6 0.1 4.0 0.1 3.3 0.1 7.5 2.7 0.9 2.5China 10.1 0.2 11.6 0.5 9.4 0.6 10.4 9.3 7.8 7.6India 5.9 0.1 8.6 0.1 7.2 0.1 11.2 7.7 3.8 5.2Indonesia 3.6 0.0 5.5 0.0 5.9 0.0 6.2 6.5 6.2 5.7Mexico 3.1 0.1 3.6 0.1 1.6 0.0 5.5 4.0 3.9 2.8Republic of Korea 6.1 0.1 4.4 0.1 3.1 0.1 6.3 3.7 2.0 1.6Russian Federation -2.7 -0.1 7.4 0.1 1.5 0.0 4.5 4.3 3.4 2.5Saudi Arabia 2.0 0.0 4.7 0.0 4.4 0.0 5.1 7.1 5.9 4.0South Africa 2.3 0.0 4.9 0.0 2.1 0.0 3.1 3.5 2.5 1.7Turkey 3.3 0.0 7.3 0.1 3.5 0.0 9.2 8.8 2.2 3.3

Source: UNCTAD secretariat calculations, based on table 1.1.Note: Data for 2013 are forecasts.

Current Trends and Challenges in the World Economy 23

Theshareofdevelopedcountriesintheglobaleconomywasabout70percentin1970andreachedalmost 80 per cent during the 1990s, following adeclineintheshareofthetransitioneconomiesdur-ingthatdecade(table1.6).Sincethebeginningofthemillennium,andespeciallyasaresultoftheGreatRecession, theshareofdevelopedcountriesintheglobaleconomyfellsharplytoabout60percentin2012.Theshareofdevelopingcountriesincreasedby7percentagepointsbetween1970and2005,andrapidlyrosebyanother12percentagepointsduringthesubsequentsevenyearstoreachover35percentofglobalGDPin2012.

Measuredintermsofpurchasingpowerparity(PPP), theshareofdevelopingcountries inglobaloutputreached47.3percentin2012,andthusalmost

matchedthatofdevelopedcountries(table1.6).Thisdoesnotmeanthatdevelopingcountrieshavebecomeas important as developed countries as drivers ofglobalgrowth,becauseacountry’scontributiontoglobalsupplyanddemand,aswellastheexpansion-aryordeflationaryimpulsesittransmitstotheothercountries,isdeterminedbythemarketvaluesofitsgoodsandservices,ratherthanbyPPPequivalents.However,itiswellknownthateconomicdevelop-ment is associatedwithan increase inacountry’spricelevels,asalsoreflectedinanappreciationofitsrealexchangerateandanensuinggradualclosingofthegapinitsPPPrelativetodevelopedcountries.18Thismeansthattheincreaseintheweightofdevelop-ingcountriesintheglobaleconomytoalmost50percent,asmeasuredinPPPterms,couldbetakentoindicatethefutureevolutionoftheirweightmeasured

Table 1.6

ShARES IN GLObAL GDP, SELECTED COUNTRIES AND COUNTRy GROUPS, 1970–2012

Market pricesa Purchasing power parityb

1970 1980 1990 1995 2000 2005 2007 2010 2012 1990 1995 2000 2005 2007 2010 2012

Developed economies 69.5 69.9 78.8 78.3 77.0 73.8 69.6 63.7 60.4 63.4 62.3 60.9 56.7 54.2 50.0 48.1

Transition economies 13.7 8.5 3.9 1.9 1.2 2.4 3.3 3.3 3.9 7.9 4.3 3.9 4.5 4.7 4.6 4.6

Developing economies 16.8 21.6 17.3 19.8 21.7 23.8 27.1 33.0 35.8 28.7 33.4 35.2 38.8 41.1 45.4 47.3Africa 2.7 3.6 2.2 1.8 1.9 2.2 2.4 2.7 2.9 3.5 3.3 3.4 3.7 3.8 4.0 4.0East, South-East and South Asia 7.5 8.3 8.1 10.1 11.0 12.8 14.8 18.9 21.3 13.6 17.8 19.7 23.2 25.3 29.0 30.7West Asia 1.3 3.2 2.0 1.8 2.2 2.8 3.1 3.3 3.6 2.9 3.0 3.2 3.4 3.5 3.7 3.9Latin America and the Caribbean 5.3 6.4 4.9 6.1 6.6 5.9 6.7 8.0 8.0 8.6 9.2 8.9 8.4 8.5 8.6 8.7Oceania 0.1 0.1 0.1 0.1 0.0 0.0 0.0 0.1 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Memo items:Argentina 1.0 0.6 0.6 0.9 0.9 0.4 0.5 0.6 0.7 0.7 0.8 0.8 0.7 0.8 0.9 0.9Brazil 1.1 1.6 1.7 2.6 2.0 1.9 2.4 3.4 3.2 3.0 3.2 2.9 2.8 2.8 2.9 2.8China 2.8 2.6 1.8 2.5 3.7 5.0 6.2 9.4 11.3 3.5 5.6 7.1 9.4 11.0 13.6 14.9India 1.9 1.6 1.5 1.2 1.4 1.8 2.2 2.6 2.6 2.9 3.3 3.7 4.3 4.6 5.4 5.6Indonesia 0.3 0.7 0.6 0.7 0.5 0.6 0.8 1.1 1.2 1.1 1.4 1.2 1.2 1.3 1.4 1.5Mexico 1.3 1.9 1.3 1.0 2.0 1.8 1.8 1.6 1.6 2.4 2.3 2.5 2.3 2.2 2.1 2.1Republic of Korea 0.3 0.5 1.2 1.8 1.6 1.8 1.9 1.6 1.6 1.3 1.7 1.8 1.9 1.9 2.0 1.9Russian Federation n.a. n.a. n.a. 1.3 0.8 1.7 2.3 2.3 2.8 5.3 2.9 2.6 3.0 3.2 3.0 3.0Saudi Arabia 0.2 1.4 0.5 0.5 0.6 0.7 0.7 0.7 0.9 0.8 0.9 0.9 0.9 0.9 1.0 1.1South Africa 0.5 0.7 0.5 0.5 0.4 0.5 0.5 0.6 0.5 0.8 0.7 0.7 0.7 0.7 0.7 0.7Turkey 0.7 0.8 0.9 0.8 0.8 1.1 1.2 1.1 1.1 1.1 1.2 1.2 1.3 1.3 1.3 1.4

Source: UNCTAD secretariat calculations, based on IMF, World Economic Outlook, April 2013; Economist Intelligence Unit, EIU CountryData database; table 1.1; and UNCTADstat.

a Calculated using dollars at current prices and current exchange rates.b Estimated on the basis of current GDP using 2005 PPP values.

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Table 1.7

gdp by Type oF expendiTuRe, seleCTed CounTRies And CounTRy gRoups, 1981–2011

Percentage of GDP Average annual growth Percentage of GDP Average annual growth

1981–1990

1991–2002

2003–2007

2008–2011

1981–1990

1991–2002

2003–2007

2008–2011

1981–1990

1991–2002

2003–2007

2008–2011

1981–1990

1991–2002

2003–2007

2008–2011

Developed economies Developing economies, excl.ChinaGDP 100.0 100.0 100.0 100.0 3.2 2.6 2.6 -0.1 100.0 100.0 100.0 100.0 3.1 3.8 5.9 3.8HH 60.7 61.1 62.1 62.7 3.2 2.8 2.5 0.3 58.7 59.5 58.8 58.8 3.1 3.8 5.5 3.6Gov 20.7 19.0 18.3 19.0 2.6 1.7 1.6 1.5 16.3 14.3 13.3 13.7 3.1 2.6 4.8 5.0Inv 18.9 20.0 20.7 18.5 4.2 3.2 4.1 -4.0 23.0 23.4 23.6 25.3 0.7 3.4 9.1 3.9Exp 13.3 19.3 24.3 26.5 4.9 6.5 6.5 0.8 23.4 32.1 41.5 42.8 3.1 7.2 10.3 3.6Imp 13.2 19.2 25.5 26.8 5.7 6.9 6.6 0.1 20.5 28.9 37.4 41.1 2.8 6.9 12.0 4.1

Developing economies Latin America and the CaribbeanGDP 100.0 100.0 100.0 100.0 3.6 4.7 7.0 5.3 100.0 100.0 100.0 100.0 1.7 2.9 4.9 2.8HH 58.3 57.3 54.6 52.9 3.7 4.4 5.9 4.5 59.9 62.5 63.2 64.7 1.6 3.0 5.2 3.3Gov 16.1 14.4 13.5 13.6 3.7 3.6 5.9 5.7 17.5 15.5 14.5 14.5 1.8 1.9 3.4 3.7Inv 24.3 25.7 27.5 30.8 1.6 4.8 10.4 7.4 21.2 21.3 20.9 22.5 -2.1 3.9 7.7 2.3Exp 22.2 30.3 40.4 42.0 3.5 8.2 12.0 5.9 11.9 18.8 24.5 23.9 4.7 7.6 7.8 1.7Imp 19.6 27.2 35.9 39.6 3.2 7.7 13.1 7.0 10.3 18.1 23.2 26.7 0.1 8.4 11.2 4.4

Transition economies AfricaGDP … 100.0 100.0 100.0 … -3.0 7.6 1.2 100.0 100.0 100.0 100.0 1.9 2.9 5.8 3.5HH … 47.0 53.2 60.8 … -1.3 10.7 3.3 61.7 62.4 62.1 62.8 1.9 3.2 5.1 4.3Gov … 20.2 16.7 15.2 … -1.8 2.7 0.8 16.0 15.6 14.7 16.0 2.7 1.6 6.5 5.9Inv … 27.1 23.1 24.0 … -12.2 14.9 -2.1 21.4 18.0 19.6 22.3 -4.5 3.2 9.3 4.5Exp … 30.8 38.6 37.0 … 1.1 8.4 0.8 29.3 33.7 36.6 35.7 1.8 4.1 8.6 0.5Imp … 23.3 31.2 35.5 … -2.7 15.5 0.9 27.3 27.1 31.9 36.3 -2.4 4.7 10.6 4.1

United States west AsiaGDP 100.0 100.0 100.0 100.0 3.6 3.5 2.8 0.0 100.0 100.0 100.0 100.0 1.4 3.7 6.9 3.7HH 66.8 67.7 70.0 70.9 3.8 3.8 3.0 0.3 49.8 51.1 52.7 53.1 3.6 3.5 7.9 2.5Gov 20.4 17.1 15.8 16.5 3.4 1.2 1.4 1.5 17.1 15.1 15.0 16.0 4.6 2.1 7.0 4.7Inv 15.4 17.7 19.4 15.7 4.1 6.6 3.7 -5.1 16.5 16.8 20.8 24.2 -0.2 3.9 15.1 4.1Exp 6.5 10.0 11.1 13.1 6.0 6.0 7.2 2.6 42.5 40.5 45.6 44.7 -3.4 5.3 9.5 2.2Imp 7.9 12.2 16.3 16.2 7.9 8.9 6.4 -0.5 26.3 23.8 34.1 39.3 1.3 4.1 16.9 2.1

Europe South AsiaGDP 100.0 100.0 100.0 100.0 2.5 2.3 2.6 -0.3 100.0 100.0 100.0 100.0 4.7 5.1 8.1 6.4HH 57.7 57.8 57.6 57.5 2.5 2.3 2.2 0.0 65.5 61.2 58.3 57.3 4.1 4.7 7.2 5.6Gov 22.4 21.2 20.4 21.1 1.9 1.6 1.9 1.3 13.6 12.2 10.9 11.3 3.0 4.7 5.9 9.0Inv 18.9 19.7 20.8 19.6 3.4 2.8 4.7 -4.2 30.3 26.8 32.1 35.8 2.7 4.1 14.2 7.4Exp 19.4 28.8 37.9 41.0 4.5 6.8 6.5 0.8 11.3 15.9 21.1 23.0 6.0 7.0 13.6 8.6Imp 18.5 27.4 36.7 39.2 5.0 6.6 6.8 0.1 15.9 16.0 22.5 27.1 0.9 6.0 17.1 9.0

Japan South-East AsiaGDP 100.0 100.0 100.0 100.0 4.6 0.9 1.8 -0.8 100.0 100.0 100.0 100.0 5.1 4.6 6.2 4.5HH 58.1 57.8 57.6 58.6 4.0 1.3 1.1 0.4 56.5 56.0 56.8 55.9 4.7 5.0 5.4 4.3Gov 15.4 16.4 18.3 19.0 3.6 3.0 1.0 1.7 11.7 10.0 10.2 10.9 3.7 4.2 5.8 6.4Inv 27.0 26.6 22.5 19.8 6.1 -1.1 1.2 -4.7 31.4 31.0 24.0 25.0 4.8 0.5 6.9 5.4Exp 8.1 9.8 14.5 15.7 4.9 3.9 9.6 -1.5 39.2 62.4 82.1 83.7 7.4 8.9 11.3 3.6Imp 7.6 10.2 12.8 13.0 5.9 4.0 4.8 -0.7 37.5 57.9 73.1 75.3 6.6 7.7 11.7 3.5

China East Asia, excl.ChinaGDP 100.0 100.0 100.0 100.0 10.3 10.1 11.6 9.6 100.0 100.0 100.0 100.0 8.7 5.4 4.9 3.3HH 53.5 45.2 38.9 35.9 11.8 8.7 8.0 8.8 57.6 59.1 55.4 53.1 8.0 5.3 3.2 2.3Gov 14.5 14.7 14.0 13.2 11.8 10.0 9.8 7.9 16.9 14.5 12.8 12.7 6.2 3.6 3.2 3.3Inv 38.0 38.3 41.7 46.4 7.9 10.6 13.4 13.4 26.8 30.5 26.5 23.1 10.4 3.7 3.8 0.4Exp 9.7 20.3 36.0 39.9 13.6 18.3 20.0 13.7 31.5 45.5 65.5 74.0 12.7 9.2 11.8 5.3Imp 9.4 17.5 30.4 35.3 14.3 17.1 18.6 18.0 32.4 49.3 61.0 63.8 12.0 7.8 9.6 3.7

Source: UNCTAD secretariat calculations, based on UNCTADstat.Note: Averages and growth rates based on constant 2005 prices and 2005 exchange rates. HH=household consumption expenditure;

Gov=government consumption expenditure; Inv=gross capital formation; Exp=exports, Imp=imports. Numbers do not necessarily add up to 100 due to rounding.

Current Trends and Challenges in the World Economy 25

inmarketvalues,providedthatthesecountriescon-tinuetheircatch-upprocess.

Thesechangesinthesharesofdifferentcoun-triesandcountrygroupsinglobaloutputandintheircontributions to global growth have been accom-paniedbychangesinthecompositionofaggregatedemandinmanyofthem.Acomparisonoftheevo-lution of private consumption, public expenditure(moreprecisely,governmentconsumption,sinceitexcludes public investment), investment, exportsand imports shows that between the 1980s and2003–2007governmentconsumptionasashareofGDPfellinthevastmajorityofregions(table1.7).Governmentconsumptioninconstantpricesrecov-eredinAfrica,latinAmericaandWestAsiaduringtheperiodof the commoditypriceboombetween2003and2007,whenmanygovernments in theseregionsusedwindfallgainstoboostsocialspending.MajorexceptionstothegeneraldeclineintheshareofcurrentgovernmentspendinginaggregatedemandwereJapan,wherespendingincreasedwithaviewtocompensatingforthesharpdeclineintheshareofprivatedemand,andChina,whereitremainedfairlystable,whiletheshareofdomesticconsumptionfell.

Thiscomparisonalso showsa slight reversalofthewidespreadtendencyofadecliningshareofgovernmentconsumptioninGDPduringtheperiod2008–2011.Thisreversalresultedfromarapidexpan-sionofcountercyclicalfiscalspendinginallcountrygroups(Griffith-Jonesandocampo,2009),19exceptintransitioneconomiesandChina.Thisexceptionispartlyduetothefactthatmostofthecountercyclicalfiscal stimulus in that country consistedof higherpublic investment rather than current expenditure.Theshareofinvestment(publicandprivate)roseby8percentagepoints,averaging46percentofGDPintheperiod2008–2011.Thiswasaccompaniedbyasignificantfallintheshareofhouseholdconsump-tioninGDPfromanaverageofover50percentinthe1980stoanaverageofabout36percentintheperiod2008–2011.

Theevolutionofthecompositionofaggregatesupplyanddemandoverthethreedecadesfrom1981to2011showsaveryrapidgrowthofexportsandimports,bothindevelopedanddevelopingcountries(table1.7).TheirshareinGDP,atconstantprices,virtuallydoubled:fromaround13percentto27percent indevelopedcountries,andfrom20percenttocloseto40percentindevelopingcountries.At

currentprices,thisgrowthwassomewhatslowerinthelattergroupofcountries(andhasevenslightlyreversed since2008) owing to a real appreciationofmost developing-country currencies during theperiod,whichresultedintheirGDPatcurrentpricesgrowingfasterthanatconstantprices.Theincreasewasmost notable in east and South-eastAsia,where the share of exports inGDP rose bymorethan30percentagepointsbetween1981–1990and2008–2011.Net exports inChina (exportsminusimports)amountedto6percentofitsGDPbetween2003and2007.

To sum up, the larger role of internationaltrade in the composition of aggregate demand indevelopingcountries’growthwasaccompaniedbyasmallerroleofgovernmentconsumptioninmostoftheseeconomies.eastAsia,especiallyChina,alsosawasignificantdeclineintheshareofhouseholdconsumptioninGDP.Untiltheearly2000s,increasedparticipation in international trade had beneficialeffectsinanumberofcountries,especiallyindevel-opingAsia,althoughmuchlesssoinlatinAmericaandAfrica.Withthegenerallyfavourableexternaleconomic environment from2003 until the onsetofthelatestcrisis,theirgreateroutwardorientationcontributed to an increase in the growth perfor-manceofallthesedevelopingregions.However,anexport-orientedgrowthstrategyalsoimpliesgreatervulnerabilitytoadeteriorationoftheexternalenvi-ronment,aswitnessedsince2008.

2. Vulnerability to trade shocks

The impactofanexport-oriented strategyonacountry’seconomicgrowthdependson theevo-lutionofglobaldemandfor thatcountry’sexportsand/or onprice developments of thosegoods thatconstitutealargeproportionofthecountry’sexportbasket.Changinginternationalpriceshavelongbeenrecognizedasamajorexternalsourceofacountry’svulnerability.Theyhaveaparticularlystrongeffectoncountriesthatexportmainlyprimarycommodi-ties, since prices of commodities have generallybeenmorevolatilethanthoseofmanufacturesandservices. in addition, the global financial crisisposestheriskofasevereslowdownofdemandformanufacturesexportedbydevelopingcountries,andafurtherdeclineinthepricesofsuchmanufactures,

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Chart 1.7

TRADE ShOCkS, by DEVELOPING REGION AND ExPORT SPECIALIzATION, 2004–2012(Change relative to GDP in previous year, per cent)

Source: UNCTAD secretariat calculations, based on UN Comtrade; UNCTADstat; United States Bureau of Labor Statistics (BLS); and CPB Netherlands Bureau for Economic Policy Analysis.

Note: A trade shock is calculated as the gains and losses in national income (measured as a percentage of GDP) resulting from changes in export volumes and terms of trade. Within each region, countries are classified by export specialization where energy, minerals or agricultural products account for at least 40 per cent, or manufactures for at least 50 per cent, of a country’s exports; all other countries are classified as diversified exporters.

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

35

All countries

Energyexporters

Mineralexporters

Agriculturalexporters

Manufacturesexporters

Diversifiedexporters

Latin America and the Caribbean

2004–2007 2008 2009 2010 2011 2012

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

35Africa

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

35West Asia

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

35East, South-East and South Asia

All countries

Energyexporters

Mineralexporters

Agriculturalexporters

Manufacturesexporters

Diversifiedexporters

All countries

Energyexporters

Mineralexporters

Agriculturalexporters

Manufacturesexporters

Diversifiedexporters

All countries

Energyexporters

Mineralexporters

Agriculturalexporters

Manufacturesexporters

Diversifiedexporters

Current Trends and Challenges in the World Economy 27

especially low-skill-intensive products (see alsochapteriiofthisReport).

Toexaminecountries’vulnerabilitytointerna-tionalpriceanddemandshocks,individualcountrieswithin each geographical regionwere classifiedaccordingtotheirexportspecialization(chart1.7).An analysis of this classification shows that bothexportersofprimarycommoditiesandexportersofmanufactures suffered severe trade shocks duringthe period 2008–2009.but it also shows that thebeneficial impact of the subsequent reboundwasbothlargerandmorerapidforcountrieswithahighshareofprimarycommoditiesintheirexportsthanforcountriesexportingmainlymanufactures.

Someobservers have interpreted developingcountries’relativelyrapideconomicgrowthinrecentyearsasamanifestationoftheir“decoupling”from

theeconomicperformanceofdevelopedcountries.This has led them to conclude that thewidelyexpected protractedweakness of demand growthin developed countriesmay not cause a sizeabledecline in developing countries’ opportunities toexportmanufactures.Rather,developingcountriescouldmovetoanewtypeofexport-ledgrowth,withSouth-Southtradebecomingthemaindrivingforce(Canuto,HaddadandHanson,2010).South-Southtradehasindeedgainedinimportance,withitsshareintotaldeveloping-countryexportsincreasingfromlessthan30percentduringthesecondhalfofthe1990stoalmost45percentin2012.Abouthalfofthisincreasehasoccurredsince2008(table1.8).

However, as alreadymentioned, the rapidgrowthindevelopingcountriesin2010wasmainlyduetotheiradoptionofcountercyclicalmacroeco-nomicpoliciesandtheirrecoveryfromtheslowdown

Table 1.8

wORLD ExPORTS by ORIGIN AND DESTINATION, SELECTED COUNTRy GROUPS, 1995–2012(Per cent of world exports)

DestinationOrigin

Developing economies

Transition economies

Developed economies Total

1995 Developing economies 11.9 0.3 16.1 28.3Transition economies 0.3 0.6 1.1 2.1Developed economies 16.6 1.1 52.1 69.7Total 28.8 2.0 69.2 100.0

2000 Developing economies 13.1 0.2 18.8 32.1Transition economies 0.4 0.5 1.4 2.4Developed economies 15.0 0.8 49.8 65.5Total 28.5 1.5 70.1 100.0

2005 Developing economies 16.7 0.5 19.1 36.3Transition economies 0.6 0.7 2.1 3.5Developed economies 13.6 1.4 45.3 60.3Total 31.0 2.5 66.5 100.0

2008 Developing economies 19.8 0.8 18.3 38.9Transition economies 0.9 0.9 2.8 4.6Developed economies 13.6 1.9 40.9 56.5Total 34.3 3.7 62.0 100.0

2010 Developing economies 23.2 0.7 18.4 42.3Transition economies 0.9 0.7 2.1 3.7Developed economies 15.3 1.5 37.2 54.0Total 39.4 2.9 57.7 100.0

2012 Developing economies 25.3 0.8 18.5 44.7Transition economies 0.9 0.8 2.4 4.1Developed economies 15.0 1.7 34.6 51.2Total 41.2 3.3 55.5 100.0

Source: UNCTAD secretariat calculations, based on UNCTADstat.Note: Numbers do not necessarily add up to 100 due to rounding.

Trade and Development Report, 201328

Table 1.9

SOUTh-SOUTh ExPORTS, by REGION AND PRODUCT CATEGORy, 1995–2012(Per cent of total South-South trade)

Share in total South-South exports of the respective product category

Average annual percentage growth

1995 2000 2005 2007 2010 20121996–2002

2003–2007

2008–2012

Asia

Asian exports to other developing countriesTotal merchandise 7.8 8.1 7.9 9.0 10.2 10.1 5.8 29.1 14.4Manufactures 9.0 9.4 9.2 11.1 13.3 13.5 5.5 28.6 14.8Primary commodities 5.2 5.4 5.4 5.6 5.4 5.5 7.2 30.7 12.6

Intraregional exportsTotal merchandise 76.5 76.7 77.1 75.3 73.7 74.4 5.4 23.5 12.1Manufactures 80.8 81.7 82.3 80.5 78.9 78.8 5.4 21.3 10.6Primary commodities 66.2 66.2 66.4 65.4 63.7 66.2 5.4 29.3 13.5

Intra- East and South-East Asian exportsTotal merchandise 58.7 55.9 53.3 49.4 46.5 45.8 4.5 20.6 11.2Manufactures 68.8 70.0 68.0 64.2 60.9 60.3 5.4 20.0 9.9Primary commodities 35.4 27.2 25.2 23.1 22.5 23.0 1.4 24.3 14.0

China’s exports to other Asian developing countriesTotal merchandise 10.6 10.9 15.9 17.4 17.0 18.2 9.1 30.1 13.1Manufactures 12.6 13.8 21.5 24.8 25.0 27.8 9.9 31.3 13.1Primary commodities 5.9 4.9 5.0 4.4 4.0 4.5 5.0 20.8 13.8

Other Asian developing countries’ exports to ChinaTotal merchandise 13.2 14.6 18.9 17.5 17.9 17.5 8.3 24.9 13.3Manufactures 15.1 17.0 22.8 21.2 21.4 19.6 9.0 23.1 10.1Primary commodities 9.2 10.0 11.6 11.1 12.5 12.9 5.6 32.3 17.9

Latin America and the Caribbean

Intraregional exportsTotal merchandise 7.7 7.7 6.3 6.2 5.2 5.0 2.8 25.2 6.8Manufactures 6.1 5.9 5.3 5.4 4.8 4.9 1.9 26.8 7.7Primary commodities 11.6 11.7 8.7 7.9 6.1 5.6 4.0 23.2 5.7

Latin American and Caribbean exports to other developing countries

Total merchandise 3.2 2.3 3.5 3.8 4.8 5.1 2.7 30.6 19.6Manufactures 1.4 0.9 1.4 1.3 1.0 1.1 0.1 24.3 5.8Primary commodities 7.3 5.3 8.0 8.7 11.7 11.7 3.9 32.7 22.4

Latin American and Caribbean exports to ChinaTotal merchandise 0.4 0.5 1.2 1.4 2.2 2.3 11.7 38.0 25.4Manufactures 0.1 0.1 0.3 0.3 0.3 0.4 20.7 20.7 13.3Primary commodities 1.3 1.2 3.0 3.6 5.6 5.5 9.8 42.7 26.8

Africa

Intraregional exportsTotal merchandise 2.3 1.8 1.7 1.7 1.8 1.6 2.1 18.9 10.2Manufactures 1.7 1.2 1.0 1.1 1.2 1.0 1.0 13.1 8.7Primary commodities 3.7 3.0 2.9 2.7 2.6 2.5 3.0 22.7 10.7

African exports to other developing countriesTotal merchandise 2.4 3.2 3.4 3.9 4.3 3.8 7.9 32.3 12.6Manufactures 0.9 0.8 0.8 0.6 0.8 0.8 1.8 18.0 12.3Primary commodities 5.7 8.0 8.5 9.6 10.3 8.5 9.9 35.3 12.3

African exports to ChinaTotal merchandise 0.2 0.6 1.1 1.4 1.7 1.1 23.2 51.0 8.4Manufactures 0.1 0.0 0.1 0.1 0.1 0.1 3.8 23.3 21.6Primary commodities 0.5 1.6 3.3 3.9 4.6 2.6 27.4 53.3 7.8

Source: UNCTAD secretariat calculations, based on UNCTADstat.Note: Shares of developing Oceania’s exports are negligible and therefore not reported.

Current Trends and Challenges in the World Economy 29

(or recession) of 2009, though their growth hasbeen losing steam since then.Moreover, a disag-gregationofdevelopingcountries’totalexportsbymajorproductcategories indicates littlechange inthe twomaincharacteristicsofSouth-South trade,namelyitsnarrowconcentrationinAsia,relatedtothesecountries’stronginvolvementininternationalproduction networks,with developed countries asfinaldestinationmarkets,andthemajorroleofpri-marycommoditiesintheexpansionofSouth-Southtradeoverthepasttwodecades(seealsoTDR 2005,chap. iV). Three quarters of South-South tradetakesplacewithinAsia,andAsianexportstootherdevelopingcountriesaccountforanother10percentofsuchtrade(table1.9).Chinaaloneaccountsforabout40percentofSouth-Southtrade,almosthalfof intra-Asian totalmerchandise trade and60percentofintra-Asiantradeinmanufactures,aswellasforaboutonethirdofalldeveloping-countryimportsfromAfrica andlatinAmerica.This implies thatChinahasprobablybeenthesinglemostimportantcountry in stimulatingSouth-South trade throughitsimportsfromotherdevelopingcountriesoverthepasttwodecades.

Moreover, the shareofmanufacturedexportsbetween countries ineast andSouth-eastAsia intotalSouth-Southtradeinmanufactureshasdeclinedsignificantlysince2000,andevenmoresosince2005(table1.9).ThisdeclineismirroredbyadeclineinChina’simportsofmanufacturesfromotherdevelop-ingAsiancountriesasashareoftotalSouth-Southtradeinmanufactures.AcontributoryfactorcouldbethedeclineinexportsfromAsiansupplychainstotheirdeveloped-countryendmarkets.20butitcouldalsobedue to the rising shareofprimaryexportsfromlatinAmericaandAfricainSouth-Southtrade.However,onacautionarynote,itshouldbeborneinmindthatthelargeamountoftradebetweengeo-graphicallyclosecountriesinvolvedininternationalproduction chains results in considerable double-countingofSouth-Southtradeinmanufactures,sincetheexportsofcountriesparticipatinginthosechainsgenerally have a high import content, and thosechainsplayanimportantroleinSouth-Southtrade.

The significant role of primary commoditiesin the dynamics of South-South exports reflects,inter alia,therapidincreaseintheabsolutevalueofSouth-Southtradeinmineralfuelsandmetals,whichhasgrownmuchmorerapidlythanthatofanyotherproductcategory,especiallysince2008(chart1.8).

on the other hand,while developing-countryexports to developed countries have grown lessrapidly, overall, low-,medium- andhigh-skill andtechnologically-intensivemanufactureswerethemostdynamicproductgroupsinSouth-Northtradeovertheperiod1995–2012,secondonlytomineralfuels.

Takentogether,thereislittleevidencetosup-porttheviewthatSouth-Southtradehasbecomeanautonomousengineofgrowthfordevelopingcoun-tries.Rather,thecloselinksbetweenthedynamicsofSouth-South trade, on the one hand, and tradein primary commodities and tradewithin interna-tionalproductionnetworkswhosefinaldestinationisdeveloped-countrymarkets,ontheother,indicatesthatengaginginSouth-Southtradehasprobablydonelittle to reducedeveloping countries’ vulnerabilityto external trade shocks.However, if developingcountriescouldshifttoagrowthstrategythatgivesagreaterroletodomesticdemandgrowth,agreatershareoftheirmanufacturedimportswouldbedes-tinedforfinaluseintheirdomesticmarketsratherthanbeingre-exportedtodevelopedcountries.SuchashiftcouldwellincreasethecontributionofSouth-Southtradetooutputgrowthindevelopingcountries.

This strengthens the argument for a renewedrolefordomesticdemandasthemotorforasustainedandbalancedgrowthoftheworldeconomy.Anothersetofadverseconditionsrelatedtotherelativelymoresubduedgrowthperformanceofdevelopingcountriesarisesfromtheheightenedinstabilityofcapitalflows.indeed,emergingeconomiessawasuddenreversalofthelargecapitalinflowstheyhadreceiveduntilearly2013, following thefirst signsofaprobablewithdrawal of quantitative easing by the FederalReserveof theUnitedStates in June2013,whichexacerbated uncertainty in the financialmarkets,withpossiblerepercussionsforthemacroeconomicpoliciesofmanydevelopingcountries.

3. Vulnerabilitytofinancialinstability

Thestrongrise incross-bordercapitalmove-ments since themid-1970shasbeenaccompaniedbyanincreaseintheshareofdevelopingcountriesasrecipientsofinternationalcapitalflows.However,capital flows to developing countries have rarelyexhibitedacontinuousandsmoothtendency;rather,

Trade and Development Report, 201330

they have frequently been punctuated by suddenreversals.Theassociatedboom-bustcyclesindomes-ticcreditandassetpriceshaverecurrentlytriggeredseverecrisesinthesecountries.Thesheermagnitudeof capital outflows fromdeveloped to developingcountries, driven by evenminor adjustments infinancialportfolios,tendtodestabilizetheeconomiesofthelattercountries,asdiscussedinchapteriiiofthisReport.

Anotherimportantfactorcontributingtodevel-opingcountries’financialvulnerabilityrelatestotheprice formationmechanisms inmarkets, includingexchangeratesandcommoditymarkets,whichcanhaveastrongimpactondevelopingcountries.Therapidlygrowingpresenceoffinancialtradersoncom-moditymarketshasoverriddenmarketmechanisms,resultinginalooserlinkbetweentheultimatesupplyordemandof thecommodityandthetreatmentofcommodity futures as afinancial asset.As traders

tendtomakepositionchangesbasedoninformationrelated toother assetmarkets, irrespectiveofpre-vailing conditions in specific commoditymarkets,theyhavetendedtogenerateapositivecorrelationbetweenthepricesofdifferentassetclasses(equityshares,currenciesusuallyusedas targets incarry-tradeoperationsandcommodityprices)(TDR 2009,chap.ii).Chart1.9showshowthepricesofdifferentkindsof assets,whichwereuncorrelateduntil theearly 2000, have become highly correlated since2002,andespeciallysince2008.Themoresynchro-nizedpricemovementsacrossthoseassetsindicateaweakeroperationoffundamentalsinpriceforma-tionineachoftheirmarkets.Forinstance,currencyappreciationordepreciationgenerallydidnotreflectcurrent account conditions in several developingeconomies: thebrazileanrealappreciated,both innominal and real terms, between 2006 and 2008,and again between2009 andmid-2011, despite apersistentdeteriorationinitscurrentaccountbalance;

Chart 1.8

EVOLUTION OF DEVELOPING-COUNTRy ExPORTS by bROAD PRODUCT CATEGORy, 1995–2012(Index numbers, 1995 = 100)

Source: UNCTAD secretariat calculations, based on UNCTADstat, Merchandise trade matrix.

0

100

200

300

400

500

600

700

1995 2000 2005 2010

Exports of developing to developed countries

0

200

400

600

800

1 000

1 200

1 400

1 600

1995 2000 2005 2010

South-South trade

Agricultural productsMineral fuels, lubricants and related materialsElectronic excluding parts and componentsParts and components for electrical and electronic goodsOres, metals, precious stones and non-monetary gold

Labour-intensive and resource-intensive manufacturesLow-skill and technology-intensive manufacturesMedium-skill and technology-intensive manufacturesHigh-skill and technology-intensive manufactures

20122012

Current Trends and Challenges in the World Economy 31

similarly,between2003andmid-2008,Turkey’srealeffective exchange rate (ReeR)21 appreciated byalmost50percent,inparallelwithagradualincreaseofitscurrentaccountdeficit.

This development has been exacerbated bytheproliferationof informationsystemsandmod-elswhicharedrivenbythesamedataandtradingprinciples(suchasso-called“momentumtrading”,“risk-on/risk-off”behavioural responsesor,gener-ally,“algorithmictrading”).Tradingbasedonthesemodelsisoftendoneveryrapidly(oftenreferredtoashigh-frequencytrading)andtendstoresultinherdbehaviour,wherebymarketparticipantsmimiceachothers’tradingbehaviour,followthepricetrendforsometimeandtrytodisinvestjustbeforetheothermarketparticipantsselltheirassets(UNCTAD,2011;bicchettiandMaystre,2012;andUNCTAD,2012).

Taken together, the above evidence indicatesthat key prices for the economies of developingcountriesmaymove inways unrelated tomarketfundamentals,andintandemwiththoseofotherassetclassessuchasequities.Theconsequenthighdegreeofcross-marketcorrelationandherdbehaviourrisksmaking global financialmarkets “thinner”, in thesensethatvirtuallyallmarketparticipantstakebetsonthesamesideofthemarket,whichmakesitmoredifficulttofindamatchingcounterpart.Thecorollarytothisisthatrelativelyminoreventscantriggeradrasticchangeofdirectioninfinancialorfinancial-izedmarkets.inaddition,suchpricechangesmaybemoresensitivetochangesinthemonetarypoliciesofdevelopedcountries,orinthegeneralriskpercep-tionprevailinginthosecountries,thanonsupplyanddemandconditions inspecificcommoditymarketsanddevelopingcountries.

Chart 1.9

pRiCe TRends in globAl AsseT MARkeTs, 1980–2012(Price index)

Source: UNCTAD secretariat calculations, based on Bloomberg.Note: World equity index refers to the MSCI world index. World commodity index refers to the S&P GSCI index. Currency index

refers to an equally weighted index, which includes the Australian dollar, the Brazilian real and the South African rand spot rates (average 1995 = 1,000).

World equity index World commodity index Currency index

0

200

400

600

800

1 000

1 200

1 400

1 600

1 800

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Trade and Development Report, 201332

1 Despite the reconstruction and rehabilitation ofmachineproductionfacilitiesintheareasofnorth-easternJapanthatwerehitby theearthquakeandtsunamiand the robustgrowthof Japan’sexportstowardsmanydevelopingcountriesinAfrica,latinAmericaandWestAsia, itsoverallexportsfell in2012forthesecondyearinarow.

2 ThedeclineinexportsfromtheislamicRepublicofiranwasprimarilyduetoatighteningoftradesanc-tionsbytheUnitedStatesandtheeU.Asaresult,itsexportsofcrudeoilandleasecondensateshrankbyabout40percent,toapproximately1.5millionbarrels per day (bbl/d) in 2012, comparedwith2.5millionbbl/din2011.

3 Atfirstsight,thisevolutionofexportsofthegroupofemergingAsianeconomiesslightlycontrastswiththepatternsofotherdevelopingregions.However,thisrelativelyhighfigureof6.2percentneedstobeviewedwithsomecaution.First,itresultspartlyfromrelativelylowlevelsinearly2012,whichtosomeextentcouldreflectdistortionsassociatedwiththeChineseNewYear.Second,CPbrobusttradedataforJanuarytoApril2013contrastwithmorenegativesignalsemanatingfromChina’scustomsfiguresforMayandJune2013.Accordingtothelattersource,thevalueofChina’sexportsshrankby3.1percentinJuneyearonyear,downfromameagre1percentinMay.Meanwhile,importsfellby0.7percentinJune,yearonyear,havingslippedby0.3percentinMay.Third,theyear-on-yearriseof17.4percentofthevalueofexportsfortheJanuary–April2013periodpresumablypartlyreflectoverinvoicingprac-ticesbyexporters speculatingon theappreciationoftherenminbi(Financial Times,“Chinatocrackdownonfakedexportdeals”,6May2013).ThesepracticeswouldalsoaffectCPb’sdataontradevol-umes.Foratleastthesereasons,itremainsdifficulttofullygraspthemagnitudeoftheslowdowninthisregion.inaddition,inalllikelihood,thesqueezeintheChinesemoneymarketandanunexpectedrisein inventories,whichareextremelydependentonchangesinthegrowthoftheeconomy,alsoplayedaroleintheserecentlowtradefigures.Nevertheless,

recentanecdotalevidenceofamarkeddeteriorationinindustrialactivity,suchasafallinoutputandinneworders,suggest thatChina’sslowdowncouldcontinue in the comingmonths (Financial Times,“Anaemicmanufacturingdata raiseChinagrowthfears”,1July2013).

4 SeeUnited StatesDepartment oflabor,bureauoflabor Statistics, at: http://www.bls.gov/news.release/empsit.t15.htm.

5 SeeStatisticsbureauofJapan,at:http://www.stat.go.jp/english/data/roudou/lngindex.htm.

6 Thisdeclineinabsolutetermswasquitegeneral:theeUlost5millionjobsbetweenthelastquarterof2007andthatof2012;theUnitedStateslost3.5millionjobsbetweenDecember2007andDecember2012;andinJapanemploymentfellby1.5millionbetweenDecember2007andMay2013,thoughthismaybepartlydue todemographic trends, as theworkingagepopulationdiminishedby5.2millionpersonsbetween1998and2012.SeeeuropeanCommissioneurostat,at:http://epp.eurostat.ec.europa.eu/portal/page/portal/employment_unemployment_lfs/data/database;UnitedStatesDepartmentoflabor,bureauoflabor Statistics, at: http://www.bls.gov/news.release/empsit.t15.htm; and Statisticsbureau ofJapan,at:http://www.stat.go.jp/english/data/roudou/lngindex.htm.

7 Multipliersdiffer,dependingonwhichexpenditureisreducedorwhichtaxisraised,andthemostcostlyare cuts in investment spending.Multipliers aremuchlower(generallybelow0.6)iffiscalconsoli-dationpoliciesarecredible(i.e.ifmarketsarecon-vincedthatannouncedconsolidationmeasureswillbefullyimplementedandenduring).basedontheseconsiderations, theeCb states that “While theremaybeatemporarydeteriorationingrowthresult-ingfromfiscalconsolidation,well-designedfiscaladjustmentleadstoapermanentimprovementinthestructuralbalanceandthushasafavourableimpactonthepathofthedebt-to-GDPratio.Consequently,postponing thenecessarybudgetaryadjustment isnotacrediblealternativetoatimelycorrectionoffiscalimbalances”(eCb,2012:81).

Notes

Current Trends and Challenges in the World Economy 33

8 AdditionalmodellingexercisesalsoshowthatthefiscalmultiplierscanhaveagreaterimpactonGDPdependingmostlyon:(i)thecompositionoftheini-tialpolicyshock,and(ii)whethertheexpansionaryshockisaccompaniedbyincomeredistributionpoli-cies.essentially,ifprogressiveincomedistributioneffectsareincludedinthedesignoffiscalmeasures,thepositiveresponsetolargergovernmentspendingishigher.Meanwhile,thenegativeeffectonGDPofincreasedtaxation,netoftransfersandsubsidies,issmallerifitconsistsofhigherdirecttaxation,andlargerifitconsistsoflowersocialtransfers.

9 Arithmetically, the overall effect on the public-debt-to-GDP ratio of a debt-financed increase inpublicspendingdependsonthevaluesofthefiscalmultiplier, thepublic revenuesasapercentageofGDPand the initialdebtstockasapercentageofGDP.Forinstance,assumingamultiplierof1.3,aninitialdebt-to-GDPratioof60percentandpublicrevenues-to-GDPratioof35percent,anincreaseof5percentofGDPinpublicspendingwouldreducethedebt-to-GDPratioto59percent.Theempiricaldebate,however,isbasicallyeconomic,andrevolvesaround the “crowding-out” debate.As stated inTDR 2011:“forthosewhobelieveincrowdingouteffects, increases in government spending reduceprivateexpenditure.inthiscase,eithersupplemen-taryspendingisfinancedwithborrowingandleadstoahigher interest rate,which lowers investmentandconsumption,or thegovernmentopts toraisetaxestobridgethefiscalgap,whichreducesprivatedisposable income and demand.Hence, publicstimuluswillbeirrelevantatbest,andmayevenbecounterproductiveifitraisesconcernsamongprivateinvestors.Theoreticalmodelssupportingthisviewhave been criticized for their unrealistic assump-tions–suchasperfectforesight, infiniteplanninghorizons, perfect capitalmarkets, and an absenceof distribution effects through taxation –whichmake themunsuitable for policy decisions in therealworld.inparticular,theirstartingpointusuallyassumes full employment,when thediscussion ispreciselyhowtorecoverfromaneconomicslump.eveninmorenormaltimes,however,theempiricalevidenceforcrowdingoutisweakatbest.”

10 “Fiscal space”mayhavedifferentmeanings.Themostcomprehensiveandusefulfromaneconomicspointofviewisthecapabilityofgeneratingafiscalstimulus thatwould improve economic andfiscalconditionsinthemediumtolongterm.Hence,evenifacountryhashighfiscaldeficitsandahighpublic-debt-to-GDPratio,agovernmenthasfiscalspace,fromadynamicperspective,ifitcanaccesslow-costfinancingandprofitfromtheveryhighfiscalmulti-pliersthatexistduringeconomicrecessions.Astaticviewoffiscalspaceonlycomparesthecurrentlevelofpublicdebtordeficitwithagiventarget(which

maybeself-imposedoragreedwiththeiMFortheeuropeanCommission).

11 This primary income is supplementedby incomeredistribution(orsecondaryincome)implementedby theState throughdirect taxation andpersonaltransfers.

12 The falling trends in the share of labour incomeareevidentinbothabsoluteandrelativeterms.inabsoluteterms,thegrowthofrealwagesofthepopu-lationinthelowersegmentsofincomedistributionhasremainedsubdued,orevennegative,inseveraldevelopedcountriesoverthepastfewdecades(see,forexample,TDR 2010).indevelopingcountries,therewas significantwage growthbetween2000and2007,butthishassloweddown,andinmanycaseshalted,sincethestartoftherecentfinancialcrisis(Ashenfelter,2012).inrelativeterms,availableempiricalanalysesofthefunctionaldistributionofincome,whichcovervariouscountries,alsopointtogrowinginequalityinthedistributionofvalueadded.labourincomeasashareoftotalincomehasbeenfallinginalmostalldevelopedcountries(StormandNaastepad,2012;TDR 2012).indevelopingcoun-tries,eventhoughempiricalevidenceisscarcerandmoreheterogeneous,theseshareshavealsodeclined,onaverage,althoughareversalhastakenplaceinthe2000sinanumberoflatinAmericanandSouth-eastAsiancountries(Stockhammer,2012;TDR 2012).

13 lookingattheworldeconomyasawhole,onaranandGalanis (2012)showthatasimultaneousandcontinuing decline in thewage share leads to aslowdown of global growth. Furthermore, in amoredetailedinvestigationof16individualcountrymembersoftheG-20,theauthorsfindthat9ofthesecountriesshowapositivecorrelationbetweenwagegrowthandGDPgrowth.oftheremaining7econo-mieswhich show negative correlations betweenwage growth andGDPgrowthwhen consideredindividually, 4 of them effectively register lowergrowthwhen facing a simultaneous reduction inthewageshare.Moreover,theyfindthatwhenthewagesharesofalleconomies fall simultaneously,these four economies contract aswell.Galbraith(2012) reaches a similar conclusion based on alargeempiricalinvestigationacrossmanycountriesand over time. in this case, however, a negativeimpactongrowthfrommoreunequaldistributionisshowntobestronglyinfluencedbythenatureofthechangesinincomedistribution,aswellasbythesocio-economiccontext and the levelofdevelop-ment.Forexample,theeffectofchangesinincomedistributiononconsumptionintheUnitedStatesoverthepast threedecades isshapedbydevelopmentsinthefinancialsector.ontheonehand,thegrowthof thefinancialsector isakeydeterminantof therapiddeteriorationofincomedistribution.(Thevastdatasampleconfirmsthatcountriesandcitiesthat

Trade and Development Report, 201334

predominantlyhostfinancialactivitiesalsodisplayahighdegreeofinequalityofincomedistribution.)ontheotherhand,theimpactonhouseholdspend-ingismediatedbytheabilityofthefinancialsectortoextendcredittoenableconsumption,whichcanlastuntilacrisisemerges.indevelopingcountries,Galbraith (2012) confirms a pattern of inequalityoverthelongrunsimilartowhatKuznetsposited,namely that rising inequality in early stages ofdevelopmentisfollowedbyimprovementsinincomedistributionasdevelopmentprogresses.However,atsomestagesandinspecificways,developmentsinthefinancialsectoralsoexertaninfluenceonhowrisinginequalityistransmittedtospending.evidencefromChina,forexample,showsthatagreatershareof the rising national income is contributing tofinancial speculation and real estate bubbles, andthushouseholdconsumptionisnotrisingasfastasnationalincome.

14 AccordingtoMinsky(1982),oneofthereasonswhyrecovery from theGreatDepressionof the1930swas so difficultwas the small amount of publicexpenditure around1930,whichwasonly10percentofGDPintheUnitedStates.

15 Forinstance,adeficitof3.6percentofGDPiscon-sistentwithadebtratiothatisstabilizedat60percentofGDP,withanannualrealGDPgrowthof3percentandanincreaseintheGDPdeflatorof3percent.

16 Theseconsiderationsmainlyconcernthedegreeofeffectiveness of themultiplier, depending on thelevel, or lack, of aggregate demand and towhatextentprivateagentsarepreoccupiedwiththeirownbalancesheets.Anotherconsiderationinassessingthegovernment’seffectivenessinsustainingdemandandemploymentrelatestothedegreeofconfidenceofprivateagentsingovernmentactions(berglundandVernengo,2004).Withasimilarconsiderationinmind,basedonanempiricalstudyof140countriesover theperiod1972–2005,Carrère anddeMelo(2012), suggest that fiscal stimulus is effectiveprovidedtherestoftheeconomyisstableandthefiscaldeficitiscontained.insum,theeffectiveness

ofpublicspendingtogeneratedemandandemploy-mentdependsnotonlyoneconomicprocesses,butalsoonpoliticalones(Kalecki,1943).

17 As stated bybernanke, “Some observers haveexpressedconcernaboutrisinglevelsofhouseholddebt, andwe at theFederalReserve follow thesedevelopmentsclosely.However,concernsaboutdebtgrowthshouldbeallayedbythefactthathouseholdassets(particularlyhousingwealth)haverisenevenmore quickly than household liabilities.”SimilarremarksweremadebyhispredecessorasChairmanoftheFederalReserveboard,AlanGreenspan,inhis testimonybefore theCommittee onbanking,Housing, andUrbanAffairs of theUnitedStatesSenateinFebruary2005(availableat:http://www.federalreserve.gov/boarddocs/hh/2005/february/testimony.htm).

18 Thisisexplainedbytheso-calledbalassa-Samuelsoneffect (i.e. price levels inwealthier countries aresystematicallyhigherthaninpoorerones).

19 TheUnitedNations(2010:tablei.4)recordedthefiscalmeasuresmadepublicbymanygovernmentsatthetimeofthecrisis.ofthe55countriescovered,the10countriesthatappliedthestrongeststimulusmeasures,allbutoneweredevelopingandtransitioneconomies.ineightofthesecountries,themeasuresamountedtomorethan10percentofGDPspreadover two to three years.However, following theimplementationofsuchhighlevelsofstimulussince2012,theremayhavebeenaturnaroundinthepaceofgovernmentspending.ortizandCummins(2013),onreviewinggovernmentprojectionsupto2016,asrecordedbytheiMF,notethattherehasbeenashifttowardsfiscalausterityby119countriesin2013,andthisislikelytoincreaseto132countriesby2015.

20 TDR 2002 (Part2,chap.iii)providesanearlydiscus-sionoftheroleofinternationalproductionnetworksin the export dynamism and industrialization ofdevelopingcountries.

21 TheReeRcorrespondstothenominalexchangerateofacurrencyvis-à-visthecurrenciesofalltradingpartners,adjustedfortheinflationdifferentials.

Current Trends and Challenges in the World Economy 35

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Alternative Scenarios for the World Economy 37

Thisannexpresentsaquantificationofglobaleconomicscenariosthrough2030.itisintendedtoillustrate alternative scenarios for a balanced andsustainedpro-growthglobaloutcomebasedontheUnitedNationsGlobalPolicyModel.1

Threesimulationsarepresented:abaselineandtwo alternative scenarios.Thebaselineisaprojectionassumingthattherewillbeneitherpolicychangesnorshocksahead.2inthetwoalternative scenarios,a reorientation ofmacroeconomic policy towardstheadoptionofmeasuresthatprovidestrongersup-portforanexpansionofaggregatedomesticdemandis assumed.Thesealternative scenarios assume acontinuingpathofeconomicconvergencebetweencountries, and incorporate the currentmacroeco-nomic constraints and potential of each economyor groupof economies. in otherwords, they takeintoaccounttheirparticularstructuralconditions,aswellas the interactionsbetweencountries throughtradeandfinance.Themaindistinctionbetweenthetwoalternativescenariosisthatinonescenarioall

countrieswould be involved in a demand-drivenpolicyeffort(scenarioA),whileintheotherscenario,only developing and emergingmarket economieswould embark on this alternativemacroeconomicpolicystance(scenariob).

Thealternativescenariosaregroundedinmacro-economicreasoning,notpoliticalfeasibility.Therefore,theydonotdiscussthepolicycoordinationprocessesthatwouldbeneededattheregionalorgloballevels,nordotheyattachanyprobabilitytotheoccurrenceofsuchprocesses.However,eventhoughthepoliticalprocessesarenotdiscussed,thesesimulationsservetoillustratetheadvantagesthatwouldresultfromacoordinated effort aimed at a sustained expansionofglobaldemand.lefttotheoperationofmarketsalone,therewouldbenoself-adjustingmechanismsfortheworldasawholetoensurecoherencebetweenthepoliciesofindividualcountriesandavoidnega-tivetrade-offsandwelfarelosses.Thequantificationsshownheremayprovidepolicymakerswithacon-cretetemplatetodebatepolicychoices.

Annex to chapter I

ALTERNATIVE SCENARIOS FOR ThE wORLD ECONOMy

Trade and Development Report, 201338

ThenatureoftheassumedpolicychangesisthesameinbothscenariosAandb,butinscenarioAallcountries,developed,developingandtransitioneconomiesalike,areassumedtopursuemoreexpan-sionarymacroeconomicpoliciestotheextentneededtoensureagrowth-enhancingenvironmentforeachcountry.Themainareasofassumedpolicychangesarelistedbelow:

• Astrongerroleofthepublicsector,bothintermsofspendinganddecisionsontaxation.Thepro-activefiscalstancewouldaimatcontributingtoastablegrowthofdemandandatstrengtheningproductivecapacitythroughphysicalandsocialinfrastructure, the provision of incentives toprivate investment and appropriate industrialandstructuralpolicies.

• Measuresaimedatamoreequaldistributionofincomethroughsettingaminimumwage,directtaxation andwelfare-enhancingprogrammes.Thesemeasures,whichwilleffectivelyleadtowageincreasesclosertoaverageproductivitygains,willplayadualrole:theywillhelpsus-taintheexpansionofaggregatedemand,and,byvirtueofsuchexpansion,theywilltriggerimprovementsinproductivitythroughdemand-driventechnicalprogressmechanisms.

• Supportivemonetary and credit policies andimprovedfinancial regulations. interest ratesandcreditavailabilityareassumedtosupportprivate and public sector activity, and at thesametimeavoidexcessiveassetappreciationsor financial fragility of private and publicinstitutions.

• Taxandspendingpoliciesareassumed tobemade consistentwith an improvement in thefinancial positions of the public sectors in

countrieswheretheyhavebeenstrainedintherecentpast.insuchcases,governmentspendingwillincreaseataslowerratethanGDPgrowth,butwillneverthelessprovideasizeableeconomicstimulusthroughspendingfiscalmultipliersthataresignificantlygreaterthan1(asexplainedinsectionbofthischapter).likewise,itwillbeassumedthatfiscalpositionswillimprovewiththehelpofhighertaxesimposedonsectorsthatarenotemployment-intensive.

• ontheexternalfront,itwouldinvolvereformsof the internationalmonetary and financialsystems.inthesescenariosit isassumedthatprogressive adjustments of nominal and realexchangerateswillbeconducivetoreducingglobal imbalances and fostering economicdevelopment.Tonarrowbothtradeandfinancialimbalanceswithout deflationary adjustmentsindeficitcountries,itisassumedthatsurpluscountrieswillmake a greater contributionthandeficitcountriesthroughmeasuresaimedat bolstering domestic demand. To enableindustrialization and export diversification indeveloping countries, it is also assumed thattherewillbenon-discriminatorymarketaccessforthesecountriesandmechanismstopromoteSouth-Southcooperation,includingintheareaof environment-friendly technologies, as dis-cussedbelow.betterregulationofcommoditymarketsisassumedtoreducetheadverseinflu-enceoftheir“financialization”onprimaryandenergyprices.

• itisfurtherassumedthatmeasures,includingincentives to private investment, governmentspending and taxation,will address environ-mentalchallengesbyhelpingtomitigatecarbonemissions and environmental degradation.3investmentsintechnologicalinnovationsforthe

The policy assumptions in the alternative scenarios

Alternative Scenarios for the World Economy 39

moreefficientproductionanduseofenergyandprimaryinputsareassumedtotakepriority.inaddition,industrialpoliciesinenergyandpri-marycommodityexporterswillaimatgreatereconomic diversification.New technologieswillbecomemoreadvancedandmadeavailableatthesamepaceasthatofothertechnologicaldevelopmentsinrecenthistory.

inscenariob,itisassumedthatthedevelopedcountrieswillmaintain their currently dominantpolicystances,andwillthereforeremainonasub-pargrowthtrajectorydrivenbyfiscalausterityandpressures to compress labour income.The lattermay contribute to competitiveness gains in exter-nalmarkets,butalsotoreducedorslowgrowthofconsumption.bycontrast,developingandtransitioneconomiesareassumedtopressaheadwiththesetofpoliciesdescribedabove,butsincetheywouldbefacing amore adverse external environment, theywouldfaceharsherconstraints.

inaddition,itisassumedthatthemajordevel-opedcountrieswillcontinuewiththeirrecentchoices

ofmonetarypolicyandfinancialregulation,whichshowedlittleconcernforpotentialspillovereffectsondevelopingcountries.Developingcountriesareassumedtoimplementsomelevelofcapitalcontrols,but,intheabsenceofinternationalcooperation,thesemeasureswillbeonlypartiallyeffective.likewise,reducing external imbalances and promoting eco-nomicdevelopmentwillbecomemorechallengingif, as assumed, developed countries donot departfromtheircurrentpolicystances.Forexample,fac-ingharsherwagecompetitionfromthelattergroup,developing countriesmaynot be able to improveon functional distribution of income to the extentthey could in scenarioA. Similarly, the greatermarket access assumed in scenarioA to enhanceexportdiversificationofdevelopingcountrieswillbeappliedonlybyandamongdevelopingcountries.overall,theseconditionswillshaketheconfidenceandexpectations thatgenerally influenceportfolioandfixed capital investment, aswell as financialcosts.butevenconsideringtheselimitations,thereremainsconsiderablescopeforcoordinationamongdevelopingandemergingeconomieswithregardtotheaforementionedpolicyalternatives.

Anillustrativesetofoutcomesresultingfromthecombinationofassumptionsinthetwoalternativescenariosispresentedbelowforthemajorregionsand for theworldasawhole.4Chart1.A.1 showsthatGDPgrowthissignificantlyhigherinscenarioAthaninbothscenariobandthebaselinescenarioforallregions.itneedstobeborneinmindthatthecurrentglobalconditionsareparticularlyadverse,asbothdevelopedanddevelopingcountriesstillfacehugechallengesandbottlenecksresultingfromthefinancialcrisis.

Thegrowthtrajectoryoutcomesfromthepolicyassumptions in scenarioA are consistentwith the

obtainedpatternsofimprovedfunctionaldistributionofincome,showninchart1.A.2.Therecentpastwasmarkedbyanunequivocaldeteriorationofincomedistributionbetweenlabourandprofitsinpracticallyallregions,withpartialexceptionsinlatinAmericaandsomeAsiancountries.Acatch-upoffunctionaldistributioniseconomicallydesirableandfeasible,butmightproceedatarelativelymoderatepace.Suchanimprovementisamajorfactorforthegrowthofinternaldemandineachcountryaswellasforthegrowthofglobaltradeactivity.inturn,economiesofscaleresultingfromlargerdomesticandforeignmar-ketsinducetechnicalprogress.buttheseprocesseswouldtaketimeandneedtobejointlymanaged,since

Outcomes of the scenarios

Trade and Development Report, 201340

Chart 1.A.1

GDP GROwTh: hISTORICAL AND ESTIMATED UNDER ThE TwO SCENARIOS, by REGION/GROUP, ChINA AND INDIA, 1995–2030

(Per cent)

Source: UNCTAD secretariat calculations, based on United Nations Global Policy Model.Note: Growth refers to GDP at constant 2005 PPP dollars. CIS includes Georgia.

World Developed economies CIS

AfricaLatin America and

the Caribbean West Asia

East, South and South-East Asia, excl. China and India China India

-2

0

2

4

6

8

1995 2000 2005 2010 2015 2020 2025 2030-4

-2

0

2

4

6

8

1995 2000 2005 2010 2015 2020 2025 2030-8

-6

-4

-2

0

2

4

6

8

10

1995 2000 2005 2010 2015 2020 2025 2030

-4

-2

0

2

4

6

8

10

1995 2000 2005 2010 2015 2020 2025 2030-4

-2

0

2

4

6

8

1995 2000 2005 2010 2015 2020 2025 2030-2

0

2

4

6

8

10

1995 2000 2005 2010 2015 2020 2025 2030

-6

-4

-2

0

2

4

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8

1995 2000 2005 2010 2015 2020 2025 20304

6

8

10

12

14

16

1995 2000 2005 2010 2015 2020 2025 20302

4

6

8

10

12

1995 2000 2005 2010 2015 2020 2025 2030

Baseline Scenario A Scenario B

Alternative Scenarios for the World Economy 41

Chart 1.A.2

LAbOUR-INCOME ShARE: hISTORICAL AND ESTIMATED UNDER ThE TwO SCENARIOS, by REGION/GROUP, ChINA AND INDIA, 1995–2030

(Per cent of GDP)

Source: UNCTAD secretariat calculations, based on United Nations Global Policy Model. Note: CIS includes Georgia.

Baseline Scenario A Scenario B

50

55

60

1995 2000 2005 2010 2015 2020 2025 2030

World

55

60

65

1995 2000 2005 2010 2015 2020 2025 2030

Developed economies

50

55

60

65

1995 2000 2005 2010 2015 2020 2025 2030

CIS

35

40

45

50

1995 2000 2005 2010 2015 2020 2025 2030

Africa

45

50

55

1995 2000 2005 2010 2015 2020 2025 2030

Latin America and the Caribbean

35

40

45

50

55

1995 2000 2005 2010 2015 2020 2025 2030

West Asia

45

50

55

1995 2000 2005 2010 2015 2020 2025 2030

East, South and South-East Asia, excl. China and India

45

50

55

60

1995 2000 2005 2010 2015 2020 2025 2030

China

35

40

45

50

1995 2000 2005 2010 2015 2020 2025 2030

India

Trade and Development Report, 201342

very rapidchanges in incomedistributionand theconsequentexpansionofGDPgrowthmaygenerateunsustainabletradedeficits.

employmentgrowthiscapturedintable1.A.1,togetherwith the growth of private consumptionand investment.Faster growthof investment, andhence employment, is expected as a result of thegrowth- and development-enhancing assumptionsofthesimulations,exceptinChinaandindia,whereinvestmentratesarealreadyveryhighandarebal-ancing towards greater domestic consumption isdue.employmentcreation isbothaneffectof thegrowthpatternsaswellasafactorforfastergrowthofconsumption.

Acriticalelementinthesimulationsisthecali-brationofthefiscalstance.Asshownintable1.A.2,robustgrowthofgovernmentspendingcanbemadeconsistentwithimprovementsinthefiscalandcurrentaccountbalances.Subjecttothelimitationsoutlinedabove,GDPgrowthhelps strengthen thefinancialpositionsofalldomesticsectors–privateandpublic.

The global configuration of imbalances pre-sented in chartA of chart 1.A.3 shows amarkedreductionofexternalimbalancesinthescenarioinwhichall countriesprovideapolicy stimulus (i.e.scenarioA).This resultsmainly from the greateremphasisofsurpluscountriesondomesticdemand,enhancedmarket access for developing countries,andareformofinternationalfinancewhichreducestheneedforcountriestoaccumulatelargeexternalreserves.

Severallessonscanbedrawnfromtheoutcomeofscenariob,inwhichdevelopedcountriesdonotadoptmoresupportivepolicies.First,itshowsthatitisworthwhilefordevelopingandtransitionecono-miestoembarkoncoordinatedpoliciesthatstimulatedomesticdemand,evenifdevelopedcountriesdonotpursuesimilarpolicies.

Second,itcanbeobservedthatdevelopedcoun-triesmanage toachievea fastergrowthrate,evenifmoremoderately, than in the baseline scenario.Thisisdespitethefactthatgrowthofpublicspend-ingisnegligibleandfunctionalincomedistributioncontinuestodeteriorate.Theoutcomedoesnotcon-tradictthepropositionsmadeinthisReport;rather,itcorroboratesthepropositionthatsuchastrategycouldyieldsomepartialgainsforsome,thoughnot

all, countries at the same time.Therewill be twodistinctiveapproaches,dependingontheprevailinginstitutional structures. Somedeveloped countrieswill continue to adopt an export-led strategy bystressingwage compressionmeasures. in deficitdevelopedcountries,somedegreeofgrowthcouldbesupportedbyreneweddebtaccumulationbythedomestic sectors.These twosetsof countrieswillinfluence the configuration of global imbalancesshown in chartbof chart 1.A.3.Greater externalimbalanceswill also affect developing countries,thoughthesewillnotbeaslargeasinthebaselinescenariobecausedevelopingcountriesareassumedtoagreeonregionalmechanismsoftradecooperation(seetable1.A.2).

Third, as stressed above,more binding con-straintsarisefordevelopingandemergingeconomiesintheimplementationandoutcomesofthepoliciesthey aim to undertake.The new configuration ofexternal imbalances suggests that therewill be abuild-upofglobalinstabilitysimilartotheoneexpe-riencedintherun-uptothefinancialcrisis.Moreover,developedcountriesareassumedtorelymoreheavilyonmonetaryexpansionmechanismswithoutacom-plementaryfiscalexpansionarystanceandwithoutsufficientlyrobustgrowthofdomesticemployment(seetables1.A.1and1.A.2).Therisksoffinancialspilloversonexchangeratesandcommoditymarketswillhavesomeeffectonthemacro-financialdeci-sionsofdevelopingcountries.insum,theexternalenvironmentthatdevelopingcountrieswillfacewillbemoreadverseinscenariobthaninthealternativescenarioA,butwill bebetter than in thebaselinescenarioowingtoenhancedregionalandSouth-Southcooperation.

in conclusion, a demand-driven coordinatedpolicyeffort(suchasinscenariosAandb)wouldleadtosignificantlybetterglobaleconomicoutcomesthan those resulting from the baseline scenario inwhichcurrentpoliciesaremaintained.Additionally,agreaterdegreeofinternationalcoordinationwoulddeliverhighergrowthratesforGDPandemploymentinallcountriesandwouldreduceglobalimbalances(scenarioA).butevenifdevelopedcountriesweretoperseverewiththeircurrentpolicystance,devel-opingcountriescouldstillimprovetheireconomicperformancebyprovidingacoordinatedeconomicstimulus.Hence,encouragingregionalcooperationandSouth-Southtradewouldneedtobeanimportantcomponentoftheirdevelopmentstrategies.

Alternative Scenarios for the World Economy 43

Table 1.A.1

PRIVATE CONSUMPTION, PRIVATE INVESTMENT AND EMPLOyMENT GAINS UNDER ThE TwO SCENARIOS, by REGION/GROUP,

ChINA AND INDIA, 2007–2030

Average annual growth of private consumption

(Per cent)

Average annual growth of private investment

(Per cent)

Employment gains(Millions of jobs

created relative to the baseline scenario)

2007–2012

2013–2018

2019–2024

2025–2030

2007–2012

2013–2018

2019–2024

2025–2030

2013–2018

2019–2024

2025–2030

World Baseline 2.9 3.1 2.9 3.0 3.7 2.6 3.1 3.8 . . .Scenario A . 4.7 5.8 6.2 . 3.5 5.8 6.4 36.6 85.9 101.8Scenario B . 3.6 4.1 4.4 . 2.7 4.0 4.9 17.6 42.2 52.5

Developed economies Baseline 1.0 1.7 1.6 1.6 -2.2 1.9 2.4 2.8 . . .Scenario A . 2.7 3.3 3.6 . 3.2 4.9 4.9 7.2 18.5 19.8Scenario B . 1.7 2.0 2.3 . 2.1 3.3 4.2 0.5 2.5 3.9

CIS Baseline 4.4 1.8 2.3 2.7 7.4 1.5 1.0 2.6 . . .Scenario A . 3.8 5.1 5.3 . 2.9 5.5 5.7 0.7 2.2 2.8Scenario B . 2.5 3.5 3.8 . 2.0 3.1 4.0 0.3 1.0 1.4

Africa Baseline 5.2 3.5 3.0 3.0 7.0 4.4 2.9 3.3 . . .Scenario A . 6.2 7.1 7.6 . 6.4 7.9 8.0 4.5 14.7 22.5Scenario B . 4.5 4.8 5.2 . 5.1 5.5 5.9 2.5 8.5 13.2

Latin America and the Caribbean

Baseline 4.0 3.0 2.7 2.7 5.0 1.7 2.2 3.2 . . .Scenario A . 4.1 5.4 5.9 . 2.1 5.5 6.2 3.4 6.5 6.9Scenario B . 3.3 3.7 3.9 . 1.5 3.3 4.2 1.9 3.6 3.4

West Asia Baseline 4.3 3.2 2.6 2.6 6.6 3.0 0.7 2.0 . . .Scenario A . 5.6 6.1 5.9 . 3.9 5.9 6.3 1.5 4.8 6.3Scenario B . 4.4 4.3 4.2 . 3.1 3.2 4.2 0.8 2.6 3.5

East, South and South-East Asia, excl. China and India

Baseline 5.1 3.9 3.0 2.9 6.5 5.4 1.6 2.4 . . .Scenario A . 5.3 6.2 6.5 . 4.8 6.8 6.9 6.2 15.4 19.3Scenario B . 4.3 4.1 4.2 . 5.2 3.5 4.1 3.8 9.7 12.0

China Baseline 8.8 8.9 7.1 6.1 11.8 3.4 5.1 5.3 . . .Scenario A . 12.3 11.1 9.5 . 3.5 5.7 6.5 8.0 12.1 9.1Scenario B . 10.8 9.3 7.8 . 3.1 4.9 5.5 4.7 7.3 6.3

India Baseline 7.8 5.2 4.8 4.7 8.4 2.2 2.2 3.7 . . .Scenario A . 8.1 9.9 10.3 . 4.7 8.9 10.0 5.0 11.8 15.2Scenario B . 6.5 7.2 7.3 . 2.9 5.1 6.5 3.0 7.2 8.8

Source: UNCTAD secretariat calculations, based on United Nations Global Policy Model.Note: CIS includes Georgia.

Trade and Development Report, 201344

Table 1.A.2

PUbLIC SPENDING, NET PUbLIC LENDING AND CURRENT ACCOUNT bALANCE UNDER ThE TwO SCENARIOS, by REGION/GROUP,

ChINA AND INDIA, 2007–2030

Average annual growth of public spending

(Per cent)

Average annual net public lending

(Per cent of GDP)Current account balance

(Per cent of GDP)

2007–2012

2013–2018

2019–2024

2025–2030

2007–2012

2013–2018

2019–2024

2025–2030

2007–2012

2013–2018

2019–2024

2025–2030

World Baseline 3.6 2.1 2.3 2.8 -3.7 -3.6 -3.2 -3.0 - - - -Scenario A . 4.0 5.7 6.2 . -2.7 -1.7 -1.7 - - - -Scenario B . 3.1 3.7 4.3 . -3.5 -2.7 -2.4 - - - -

Developed economies Baseline 1.6 0.5 0.7 0.8 -5.6 -4.9 -3.7 -3.0 -0.5 -0.4 -1.3 -2.4Scenario A . 1.2 3.0 3.5 . -3.7 -2.5 -2.5 . -0.4 -0.5 -0.8Scenario B . 0.6 0.9 1.3 . -4.8 -3.2 -1.9 . -0.3 -0.5 -0.9

CIS Baseline 3.1 2.0 1.6 1.7 1.2 0.6 0.4 0.9 2.5 0.2 0.7 1.4Scenario A . 3.0 4.9 5.4 . 1.1 0.9 0.2 . 0.7 0.6 0.5Scenario B . 2.5 3.5 3.8 . 0.7 0.2 -0.1 . 0.3 0.3 0.5

Africa Baseline 7.2 1.6 1.2 2.2 -2.7 -4.3 -2.5 -1.1 -1.6 -4.3 -6.4 -5.8Scenario A . 2.9 6.8 7.6 . -2.8 -1.0 -1.1 . -2.3 -1.5 -0.2Scenario B . 2.2 4.2 5.0 . -3.7 -2.4 -2.0 . -3.6 -4.6 -4.0

Latin America and the Caribbean

Baseline 5.8 2.2 1.8 2.3 -2.4 -3.6 -3.2 -2.6 -2.7 -3.5 -3.8 -3.4Scenario A . 4.1 5.5 6.0 . -3.0 -2.4 -2.5 . -2.5 -0.7 0.1Scenario B . 3.1 3.7 4.0 . -3.5 -3.4 -3.4 . -3.1 -2.6 -2.0

West Asia Baseline 5.0 3.0 1.8 2.8 4.7 0.5 -0.7 -0.1 7.9 2.4 0.8 2.0Scenario A . 3.8 5.5 5.9 . 0.9 -0.7 -0.7 . 4.3 1.5 0.8Scenario B . 3.3 3.9 4.5 . 0.5 -1.0 -1.0 . 3.3 0.8 0.8

East, South and South-East Asia, excl. China and India

Baseline 5.5 3.3 2.4 2.8 -2.8 -2.9 -3.2 -3.0 -1.6 -4.2 -4.5 -3.3Scenario A . 8.5 7.1 6.8 . -2.8 -2.8 -2.9 . -2.2 -0.5 0.0Scenario B . 6.2 4.8 4.7 . -3.0 -3.6 -3.8 . -3.7 -3.6 -2.9

China Baseline 9.0 7.1 7.3 6.6 -1.0 -0.2 -1.3 -2.5 4.8 6.8 8.4 8.3Scenario A . 12.2 9.9 8.7 . -0.1 -0.0 -0.0 . 3.3 1.6 1.5Scenario B . 10.4 8.8 7.8 . -0.3 -1.0 -1.5 . 4.6 3.9 3.6

India Baseline 9.7 4.9 4.7 4.9 -8.3 -9.6 -10.0 -10.1 -6.0 -4.8 -2.7 -1.9Scenario A . 9.4 10.2 10.3 . -6.2 -3.1 -3.0 . -4.5 -1.8 -1.1Scenario B . 7.4 7.6 7.7 . -7.9 -6.7 -6.9 . -4.7 -2.7 -2.2

Source: UNCTAD secretariat calculations, based on United Nations Global Policy Model.Note: CIS includes Georgia.

Alternative Scenarios for the World Economy 45

Chart 1.A.3

globAl iMbAlAnCes undeR Two sCenARios, 1980–2030(Per cent of world output)

Source: UNCTAD secretariat calculations, based on United Nations Global Policy Model.Note: The shaded area shows the simulation period. Deficit and surplus classification was based on the average current account (CA)

position between 2004 and 2007. CIS includes Georgia.

-3

-2

-1

0

1

2

3

1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030

A. Scenario A

-3

-2

-1

0

1

2

3

1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030

B. Scenario B

Oil-exporting economies

CA deficit developing economiesCA surplus developing economies, excl. ChinaCA deficit developed economiesCA surplus developed economies China

CIS

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1 TheUNGlobalPolicyModelcanbeaccessedat:http://www.un.org/en/development/desa/policy/publications/ungpm/gpm_concepts_2010.pdf.Theversionused in thisReport–number5b– incor-poratesemploymentandfunctionaldistributionofincomeandtheirfeedbacksintothemacroandglobaleconomy.Thefulltechnicaldescriptionofthemodel,version 3, can be downloaded from: http://www.un.org/en/development/desa/policy/publications/ungpm/gpm_technicaldescription_main_2010.pdf.

2 These assumptions of no policy changes and theabsence of shocks fromnow to 2030 are clearlyunrealistic,butareconvenientinordertonetouttheimpactofthepolicychangesanalysedintheothertwoscenarios.

3 TheGPMhastheabilitytoquantifyboththeintensityofuseofrawmaterialsintheproductionofdomesticoutputanddifferentiatedpatternsintheuseoffossil-fuelandnon-fossil-fueltechnologies.

4 Theassumptionsdiscussedaboveimplyconsider-ingtrade-offsandinteractionswithinandbetweeneconomies.Depending on how these trade-offsaremanaged, different outcomesmay result. Forexample,highergrowthtargetscouldbeachievedinsomedevelopingcountriesifothercountriesagreetowidertradepreferences.Similarly,somecountriescouldgrowfasterorslowerdependingonthelevelsofexternaldeficitsandsurplusesthatcountriesarepreparedtotolerate.

Notes

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 47

Theglobaleconomyisstillstrugglingtorecoverfrom theGreatRecessionof 2008–2009 resultingfrombustsinthehousingandfinancialmarketsofthemajordevelopedcountries.TheexaminationofthecurrentchallengesfortheglobaleconomyinchapteriofthisReportindicatesthatthesecountriesmayhavealongwaytogotoachieveaself-sustainingrecovery.Meanwhile,aprolongedperiodofslowgrowth inthesecountrieswillmeancontinuedsluggishdemandandthusslowergrowthintheirimportsfromdevelop-ingandtransitioneconomiesbeyondtheshortterm.Countercyclicalmacroeconomicpoliciesmight beable to compensate for resultinggrowth shortfallsforsometime,butwilleventuallyresultinfiscalorbalance-of-paymentsconstraintsunlesstheyarefol-lowedbypoliciesthatadoptamorecomprehensiveandlongertermperspective.Thischapterdiscussespossiblelongertermpolicyoptionstosupportrapidandsustainedeconomicgrowthindevelopingandtransitioneconomies,withafocuson thecomple-mentarityofexternalanddomesticdemand.

Priortotheonsetoftheeconomicandfinancialcrisis,buoyantconsumerdemandinsomedevelopedeconomies,especiallytheUnitedStates,enabledtherapidgrowthofmanufacturedexportsfromindus-trializing developing economies.The consequent

boost to these countries’ industrial developmentandurbanization,inturn,providedopportunitiesforprimarycommodityexportsfromotherdevelopingcountries.Theoverallexpansionary–thougheven-tuallyunsustainable–natureofthesedevelopmentscontributedtoaprolongedperiodofoutputgrowthoftheworldeconomy,andseemedtovindicatemanydevelopingandtransitioneconomiesintheirdecisiontoadoptanexport-orientedgrowthmodel.However,their continued reliance on such a growthmodeldoesnotseemviableinthecurrentcontextofslowgrowthindevelopedeconomies.Accordingly,thosedevelopingandtransitioneconomies,andespeciallythelargeronesamongthem,mayneedtoconsiderapolicyshifttoamoredomestic-demand-orientedgrowthmodel.

This chapter examines twomain questions:(i)Whatdetermineswhetherdevelopingandtran-sition economies should shift emphasis from anexport-orientedtoamoredomestic-demand-orientedgrowth strategy? (ii)What policymeasures couldhelpsmoothsuchatransitioningrowthstrategy?

Thechapterfirstdiscusses,insectionb,deter-minantsofcountries’vulnerabilitytoexternaltradeshocks. itemphasizes that thedecline inrealfinal

TOwARDS MORE bALANCED GROwTh: A GREATER ROLE FOR DOMESTIC DEMAND

IN DEVELOPMENT STRATEGIES

Chapter II

A. Introduction

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expenditurewasthemainreasonforthecollapseofinternationaltradein2008–2009.Combinedwiththerecognitionthatgrowthindevelopedcountries’finalexpendituremayremainbelowpre-crisisratesforaprotractedperiodoftime,itarguesthat:(i)theeffectsofthetradecollapseonmanufacturedexportsfromdevelopingandtransitioneconomiesmaybeindica-tiveofalessfavourableexternaltradeenvironmentforthesecountriesforanumberofyearstocome;and(ii)possibleensuingslowerdemandgrowthinthedevelopingandtransitioneconomies thathavealargeproportionofmanufacturesintheirexports,combinedwithweakgrowthindevelopedcountries,mayalsoreducetheexportearningsofeconomiesthatrelymainlyonexportsofprimarycommodities.in evaluating possible future developments in thelattercountries’exportearnings,thissectionfurthersuggeststhatthiscoulddependtoalargeextentonwhethercommoditypricesareinaso-called“super-cycle”,andifso,atwhatpointinthecycletheyarecurrentlysituated.Whileeconomicactivityindevel-opedcountriesclearlyhasadirectimpactonprimarycommodity price developments, its largest impactmaybeindirectandlinkedtoitseffectonthepaceofindustrializationandurbanizationindevelopingandtransitioneconomieswhosegrowthtrajectorieshavebeensupportedbyexportsofmanufacturestodeveloped-countrymarkets. SectionC focuses onmanufactures,andexamineswhichcategoriesmaybeparticularlyaffectedbyweakdemandgrowthindevelopedcountries.

SectionD considers economic growth froma demand-side perspective. it begins from themain conclusion of the previous section, that thescopeforaswitchtowardsamorebalancedgrowthstrategyisgreatestfor thosecountrieswhichhaverelied significantly on exports ofmanufacturesto developed countries. it then builds on anexamination(presentedintheannextothischapter)ofwhatsuchaswitchfromanexport-orientedtoamore domestic-demand-oriented growth strategywould entail in economic terms. it discusses thepossible implications for countries’ balance ofpaymentsandforproduct-specificdemandpatternsresulting from an acceleration of expenditure inthe different components of domestic demand(i.e. household consumption, investment andgovernmentspending).Particularattentionisgivento household consumption expenditure,which isbyfarthelargestcomponentofdomesticdemand,generally accounting for between half and three

quartersofaggregatedemand.Therefore,anincreaseinthiscomponentwouldappeartobeindispensableforsustainedgrowthbasedonastrategythatplacesgreateremphasisondomesticdemand.Thesectionalsounderlinestheimportanceofbothgovernmentspending and, especially, investment for boostingdemandgrowth.This isparticularlytrueformanycountries inlatinAmerica,where,despiteamorerapidpaceofgrossfixedcapitalformationstartingintheearly2000s,theshareofinvestmentingrossdomesticproduct(GDP)hasremainedrelativelylowandconstrainstheirpotentialgrowth.butitisalsotrue for other developing countries, especially ineastAsia,whereinvestmentisrequiredinordertoswitchdomesticsupplycapacitiestomeetchangingdemandpatternsthataredrivenbyrisinghouseholdconsumptionexpenditure.

The following are themain findings of thissection. First, amore balanced growth strategywithalargerrolefordomesticdemandneedstobebasedonthecreationofdomesticpurchasingpowerthrough additional employment andwage-earningopportunities. Second, it is necessary tomanagedomesticdemandexpansiontopreventanexcessiveincreaseindemandforimportsarisingfromaswitchin growth strategy, which, coupledwith lowerexport growth,might cause a deterioration in thetradebalance.Third,nurturingtheinterrelationshipbetween household consumption and investmentwill be of crucial importance in a shift towards amore balancedgrowth strategy. investment needsto be increased, not only to create the jobs andincomesnecessaryforsustainedgrowthofhouseholdconsumptionexpenditure,butalsotoenablechangesinthesectoralcompositionofdomesticproductionsothatitrespondstosalesopportunitiesarisingfromnewdemandsbydomesticconsumers.Thelatteristrueespeciallyfor largecountries,while forsmallcountries an increase in regional andSouth-Southtradeislikelytobeofparticularimportance.

Sectionediscussesthepolicyimplicationsofthesefindingsatboththenationalandinternationallevels to help smoothen the transition from onegrowth strategy to another. it emphasizes that themajor policy challenges facing developing andtransitioneconomiesdiffersignificantlyfromthosefacingthedevelopedeconomies.Thelatterstillneedtofocusonconsolidatingtheirweakenedfinancialsystemsandondemandmanagementinanefforttoreturntoapathofsustainedeconomicgrowth,high

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 49

levelsofemploymentand sociallyacceptabledis-tributionaloutcomes.Succeedinginthistaskwouldalsohaveglobalbenefits.itwouldmaintain,andevenenlarge,thekindofexportopportunitiesthatunder-pinnedmuchofthesuccessfulgrowthofdevelopingandtransitioneconomiesduringthepre-crisisperiod.However,suchanoutcomeisunlikelytooccurforseveral years to comebecause, to a large extent,exportsofdevelopingand transitioneconomies todeveloped-countrymarketsduringthedecadebeforetheonsetoftheGreatRecessionreliedonunsustain-ablepolicystancesinthedevelopedcountries.

itisclearthatdevelopingandtransitioneconomiesshouldnotneglectdemandmanagement;rather,theyshouldmaintainpoliciesaimedatbothstrengtheninggrowth and employment creation and at reducingdomesticandexternalvulnerabilities.Nevertheless,the policy stance of developing countries needsto adapt to an external economic environmentcharacterizedbyslowrecoveryandweakgrowthindevelopedeconomies.Suchadaptationimpliestheneed foragradual shift in the relative importanceof external sources of growth towards a greateremphasisondomesticsources.

Countriesexportingprimarycommoditiesaregenerally believed to be particularly sensitive tochangesintheglobaleconomicenvironmentfortworeasons.one reason relates to commodity prices,whichexperiencefrequentandoftensharpfluctua-tions.Anotherconcernsvolumes,andthefactthattheincomeelasticityofdemandforprimarycommod-itiesislowerthanthatformanufactures.Thismeansthatdemandprospectsforexportersofmanufacturestendtobemorefavourablethanthoseforexportersofprimarycommoditiesasworldincomerises.Thissectionexaminesthepriceandvolumeeffectsofthecollapseofglobaltradein2008–2009andprospectsforthefuturegrowthofdemandforprimarycom-moditiesandmanufacturesrespectively.

1. Volume and price components of external trade shocks

Greater trade openness has helped promoteeconomic growth in a number of countries, but,increasingly,ithasalsobecomeaprimarychannelfor the transmissionofexternalshocks.economic

downturnsindevelopedcountriescausesharpcon-tractions in global demand and reduce the exportopportunitiesofdevelopingcountries.Thiscanresultinanexternaltradeshockfordevelopingcountries,reflected in a decline in their export volumes andchangesintheirtermsoftrade(i.e.thechangeinacountry’saverageexportpricerelativetoitsimportprice).Theimpactofsuchexternaltradeshocksvariesconsiderablyacrossregionsandindividualcountries,dependingontheirpatternofexportspecialization.

The collapse ofworld trade in 2008–2009caused a deterioration in the terms of trade ofcountrieswhose exports are heavily concentratedinenergy,andcountries thatexportmainlymanu-facturedgoodsexperiencednegativevolumeeffects(chart 2.1).1Terms of trade and volume changeswere equally important in countrieswhich exportpredominantlymineralsandmetals,asincountrieswhoseexportsareeitherdiversifiedorconcentratedinagriculturalproducts.

Theremainderofthissectionexaminesissuesrelated to changes in the prices of primary com-modities before turning to demand prospects formanufacturedexportsfromdevelopingcountries.

b. Global trade shocks and long-term trends: terms-of-trade and volume effects

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2. Recent movements in the terms of trade

Pricemovements of internationally tradedgoods affect an individual country’s gains frominternationaltrade,oritstermsoftrade.Theextentofgainsorlossesresultingfromchangesinthetermsoftradedependsonthecompositionofthecountry’stradebasketandtherelativeimportanceofforeigntradeinitsgrossdomesticproduct(GDP).Primarycommodity production and exports are generallybelievedtoofferlimitedopportunitiesforeconomicgrowthanddevelopmentmainlybecauseofalong-runningdeteriorationinthetermsoftradeofprimarycommoditiesversusmanufactures (i.e.adecliningtrendinthepricesofprimarycommoditiesvis-à-visthoseofmanufactures)(chart2.2).otherdimensionsof the “commodity problem” relate to high pricevolatilityandtheconcentrationofmarketstructures

that limits the share of thefinal price accruing toproducers.

Sincetheturnofthemillenniumtherehasbeenasignificantimprovementinthetermsoftradeforcommodityexportersvis-à-visexportersofmanufac-tures,whichhasalsocontributedtofastereconomicgrowth in commodity-exporting countries. Thecommoditypriceboomovertheperiod2002–2008andanotherrapidreboundfollowingasharppricedeclinein2008–2009(seechart1.2andtable1.3inchapteri)reflectachangeinthecommoditypricetrend,at least temporarily, fromdecliningtowardsrisingprices;buttheyalsoreflectadeclineinworldpricesofcertain,especiallylabour-intensive,manu-factures.Thisturnaroundisrelatedtotwostructuralchangesininternationaltradeinwhichdevelopingcountrieshaveplayedamajorrole:first,anumberofdevelopingcountries,notablyChina,haveemergedasmajorconsumersandimportersofcommodities;

Chart 2.1

The globAl TRAde CollApse oF 2008–2009: MOST AFFECTED ECONOMIES, by ExPORT SPECIALIzATION

(Trade shocks as a percentage of GDP)

Source: UN-DESA, 2009.

-35 -30 -25 -20 -15 -10 -5 0 5

Brunei Darussalam

Bahrain

Iraq

Gabon

Saudi Arabia

Trinidad and Tobago

Kuwait

Oman

Qatar

Algeria

Volume effectPrice effect

Singapore

Hong Kong (China)

Malaysia

Viet Nam

Taiwan Province of China

Cambodia

Thailand

Mexico

China

Tunisia

A. Economies in which energy accounts for more than 40 per cent of exports

B. Economies in which manufactures account for more than 40 per cent of exports

-35 -30 -25 -20 -15 -10 -5 0 5

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 51

andsecond,manufacturesnowaccountforasizeableshareofsomedevelopingcountries’exportbaskets.

Terms-of-trade trends for different groupsof developing countries have tended to diverge(chart2.3),dependingon thecompositionof theirrespective exports and imports.Those developingcountrieswhoseoilandmineralandminingprod-ucts account for a sizeable share of total exportsexperiencedthelargestgainsfromhighercommod-ity prices vis-à-vismanufactures since the early2000s.oilexporterssawtheirtermsoftrademorethan double in the past decade, implying that thepricesoftheirexportsgrewmorethantwiceasfastasthepricesoftheirimports.Mirroringthesetrendsbygeographicalarea, thecountrygroups that sawthelargestterms-of-tradegainswerethetransitioneconomies,AfricaandWestAsia.Similarly,latinAmericaregisteredsignificantterms-of-tradegains,althoughmoremoderate because of a relativelymorediversifiedtradestructure.Thetermsoftrade

ofexportersofagriculturalcommoditiesshowedaslightlyrisingtrend,reflectingbothdissimilarpricedevelopments for different agricultural products(i.e. tropical beverages, food and agricultural rawmaterials)andthedifferentweightsoffoodandfuelimportsintheirimportbaskets.ontheotherhand,developing countries that aremajor exporters ofmanufactures,mainlythoseineastandSouthAsia,haveexperiencedterms-of-tradelossessince2000.2

in2010and2011,thetermsoftradeofcommod-ityexporters recovered from thecommoditypriceslumpof2009inwhatappearedtobeacontinuationoftherisingtrendsincetheearly2000s(chart2.3A).However, in2012 their termsof tradestalledasaresultofadeclineofcommoditypricesfromtheirpeaks in 2011 (see discussion about recent com-moditypricedevelopments inchapter i).Whetherthisrepresentsjustapauseorareversaloftherisingtrendintheirtermsoftradeduringthe2000sisthefocusofthenextsection.

Chart 2.2

TRENDS IN ThE TERMS OF TRADE, SELECTED PRIMARy COMMODITy GROUPS veRsus MAnuFACTuRes, 1865–2009

(Index numbers, 1970–1979 = 100)

Source: Ocampo and Parra, 2010.

0

50

100

150

200

250

300

1865 1890 1915 1940 1965 1990

Tropical agricultural

Non-tropical agricultural

20090

50

100

150

200

250

300

1865 1890 1915 1940 1965 1990 2009

A. Agricultural commodities versus manufactures B. Metals versus manufactures

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3. Factors affecting commodity prices: is a supercycle petering out?

Commoditypricesareinfluencedbyacomplexinteractionofmultiplefactors,whichcanspandif-ferenttimeperiodsandcanaffectthevolatilityand/orthetrendlevelofthoseprices.Commoditypricedevelopmentsaredeterminedbythefundamentalsofphysicalsupplyanddemandofcommodities,aswellasbythegreaterparticipationoffinancialinvestorsinprimarycommoditymarkets,becausecommoditiesareincreasinglyconsideredafinancialasset.Anotherfactorinfluencingcommodityprices,whicharenor-mallydenominated inUnitedStatesdollars, is theevolutionoftheexchangerateofthedollar.Therearealsosomefactorsspecifictoaparticularcommoditymarket,whileothersaffectallprimarycommodities.Furthermore, it is not onlymarket-related factors,butalsoeconomicpolicyandpoliticalaspectsthatmatter. For example, geopolitics can have a verysignificantinfluenceontheevolutionofoilprices.While a precisemeasurement of the influence ofeachindividualfactoronthedynamicsofcommodity

pricesisfraughtwithdifficulties,especiallyforpriceforecasting,theobjectiveofthissectionistoprovideabroadassessmentofthelikelytrendofcommoditypricesoverthenextoneortwodecades.

During the past decade, commoditymarketshaveexperiencedsubstantialstructuralchanges.onesuchchangeistheincreasingpresenceoffinancialinvestorsincommoditymarkets(seealsoTDR 2009,chap.ii;TDR 2011,chap.V).Financialinvestmentshaveasignificantimpactonpricevolatilityandmaycauseextremepricechangesintheshortterm;forinstance, thecommodityprice surges in2007andthefirsthalfof2008weremostprobablylinkedtoaspeculativebubble,whichburstwiththecollapseofpricesinthesecondhalfof2008followingtheonsetoftheglobalfinancialcrisis.Asecondmajorstruc-turalchange,associatedwiththeunderlyingphysicalmarketfundamentals,istheincreasingdemandforcommodities in rapidlygrowingdevelopingcoun-tries,notablyChina.

The latter factor,which is themain focus ofthissection,hasmoreofaninfluenceonthelonger

Chart 2.3

NET bARTER TERMS OF TRADE, 2000–2012(Index numbers, 2000 = 100)

Source: UNCTAD secretariat calculations, based on UNCTADstat.Note: Data for export structure refer to developing and transition economies.

60

80

100

120

140

160

180

200

220

240

2000 2002 2004 2006 2008 2010 2012

A. By export structure

Oil exporters

Exporters of minerals and mining products

Exporters of agricultural products

Exporters of manufactures

60

80

100

120

140

160

180

200

220

240

2000 2002 2004 2006 2008 2010 2012

B. By region and economic group

AfricaLatin America and the CaribbeanEast and South AsiaWest AsiaTransition economiesDeveloped economies

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 53

term trend of commodity prices.on the demandside, it has underpinned the sustained increase incommodityprices since2003 thatwas interruptedonlyin2008–2009byasharpfallinpricesfollow-ingtheeruptionoftheglobalfinancialcrisis.onthesupplyside,thehistoricallylowpricelevelsofthe1990s led to a longperiodof underinvestment inproductioncapacity.Asaresult,andduetoincreasingproductionconstraints,supplywasslowtoreacttorisingdemand.Consequently,withstocksgenerallydeclining, the trendwas forprices to significantlyincrease.The tight structural supply and demandbalancesofmanycommoditiesalsopavedthewayforotherfactorsfromthefinancialsectorandpolicysidetoleadtoexcessivepricevolatility.

Someobservershave identifiedthecommod-itypricesurgebetween2002and2011–2012astheexpansionary phase of a commodity “supercycle”–i.e.atrendriseinthepricesofabroadrangeofcommoditieswhichmaylasttwodecadesormore.itisassociatedwithrisingdemandinamajorcountryorgroupsofcountriesresultingfromtheirprocessof industrialization andurbanization (Heap, 2005;Standard Chartered, 2010; erten andocampo,2012;Farooki andKaplinsky, 2012).3The currentsupercyclehasbeencharacterizedbyrapideconomicgrowth,industrializationandurbanizationinarangeof developing countries, amongwhichChina hasplayedaparticularlystrongrolebecauseofthelargesizeofitseconomy.economicgrowthinChinahasbeen extremely natural-resource-intensive, partlydrivenbyhigh levels of investment, especially ininfrastructure and construction, and by the rapidgrowthofmanufacturing,whichgenerallydemandsmorerawmaterialsandenergythangrowthintheservices and agricultural sectors. Consequently,Chinahasbecometheworld’sleadingconsumerofmany primary commodities, accounting formorethan40percentofglobalconsumptionofseveralcommodities(table2.1).Atthesametime,itisalsoamajorproducerofanumberofcommodities.butwhileChinesecommodityproductionincreaseddur-ingthefirstdecadeofthe2000s,thiswasnotalwayssufficient tomeet the rising demand.As a result,Chinahasbecomeamajorimporterofsomecom-modities(eClAC,2012:boxii.3),notablyironoreandsoybeans.indeed,itaccountsforabout60percentoftotalworldimportsofboththesecommod-ities.Chinaisalsoamajorimporterofothermetalssuchascopperandnickel,andofagriculturalrawmaterialssuchascottonandnaturalrubber.Demand

forcommoditiesstronglyincreasedinotherrapidlygrowingdevelopingcountriesaswell,buttoamuchlesserextent(table2.1).Andindevelopedcountries,demand for some commodities declined between2002and2012.

The increasing roleofChinaonglobal com-moditymarketsisduenotonlytothelargesizeofitseconomybutalsotothenatureofitsgrowth.itisforthisreasonthattherecentslowdowninChinesegrowthaswellasitsprocessofgrowthrebalancing,involving less relianceon exports and investmentandgreatereffortstopromotedomesticconsumption,havereignitedthedebateonwhethertheexpansion-ary phase of the commodity supercyclemight becomingtoanend.Theloweraverageannualcom-moditypricesof2012comparedwiththoseof2011couldbeconsideredanindicationofsuchapossibil-ity.Certainly,priceswillstoprisingatsomepointassupplyanddemandadjust;eventually theywillreachanupperlimitwhereupontherewillbedemanddestruction,substitutionandtechnologicaladvancesinsearchofgreaterefficiencyofuse,and/orincreasesinsupplyasaresponsetohighprices.However,thequestionthatremainsunresolvediswhethersuchaturningpointhasbeenreachedorwhethertheexpan-sionaryphaseof thesupercyclestillhasanumberofyearstorun.ifindeedtheturningpointhasbeenreached,anadditionalquestioniswhethercommod-itypriceswillplungeinadescendentphaseofthesupercycle,orwhethertheywillremainatrelativelyhighlevels.inthelatterscenario,theriseincommod-itypricesshouldbeseenmoreasanupwardshiftthanastheexpansionaryphaseofthecycle.

Historical evidence shows that price trendshavebeencloselyrelatedtotheevolutionofglobaleconomicactivityandaggregatedemand,particularlyformetals(ertenandocampo,2012).episodesofrisingpriceshavenormallyendedinpricecollapseswhendemandhasfallenasaresultofadecelerationofglobalgrowthorarecession.Asimilaroutcomecouldbe expected in the current context if globaleconomicgrowthremainsweakduetoslowgrowthor stagnation in developed economies.However,theanalysisofcommodityconsumptionintable2.1clearlyshowsthattheriseincommoditypricesinthe2000swasstronglydeterminedbydevelopmentsindevelopingcountries.itisthereforethegrowthout-lookforthesecountriesthatmattersmostforfuturecommoditydemandtrends.inparticular,thisimpliesthatifChinaweretocontinuetodependonitsexports

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Table 2.1

CONSUMPTION OF SELECTED COMMODITIES, by REGION AND ECONOMIC GROUP, 2002–2012(Per cent)

A. Consumption growth between 2002 and 2012

China

Other Asia and Oceania, developing Africa

Latin America and the

CaribbeanTransition economies

Developed economies

World total

Aluminium 392.7 105.2 101.8 54.6 -13.0 -4.4 78.5Copper 223.0 12.6 70.2 32.4 88.3 -23.4 35.8Nickel 894.1 -2.5 -9.1 -14.6 -4.8 -22.0 48.0Cotton 24.4 31.4 -21.4 3.1 -13.6 -67.6 9.6Corn 66.4 40.8 50.4 42.7 48.2 24.5 39.6Meat, swine 26.6 31.3 99.2 38.7 34.4 -0.5 17.8Rice 6.1 18.0 61.2 9.1 14.2 5.3 15.0Wheat 16.9 19.4 42.6 14.9 -2.4 4.2 13.0Soybeans 117.7 60.8 109.8 37.8 272.6 -12.7 36.5Oil 95.4 33.9 36.3 25.2 18.8 -8.1 13.5

b. Contribution to global consumption growth between 2002 and 2012

China

Other Asia and Oceania, developing Africa

Latin America and the

CaribbeanTransition economies

Developed economies

World total

Aluminium 81.1 18.4 1.8 2.8 -0.7 -3.4 100Copper 113.4 6.9 1.9 4.8 7.4 -34.5 100Nickel 132.3 -1.0 -0.6 -0.7 -0.3 -29.7 100Cotton 74.9 135.4 -6.5 2.5 -5.0 -101.2 100Corn 33.7 10.4 10.0 14.2 3.2 28.5 100Meat, swine 69.8 10.3 1.5 11.2 8.3 -1.0 100Rice 13.6 64.6 17.6 2.5 0.3 1.4 100Wheat 22.6 40.9 23.4 6.0 -2.4 9.5 100Soybeans 59.6 13.3 2.3 34.3 4.2 -13.6 100Oil 48.2 53.1 9.1 16.2 6.9 -33.4 100

C. Share in global consumption

China

Other Asia and Oceania, developing Africa

Latin America and the

CaribbeanTransition economies

Developed economies

2002 2012 2002 2012 2002 2012 2002 2012 2002 2012 2002 2012

Aluminium 16.2 44.8 13.7 15.8 1.4 1.6 4.0 3.5 4.4 2.2 60.2 32.3Copper 18.2 43.3 19.8 16.4 1.0 1.2 5.2 5.1 3.0 4.2 52.7 29.8Nickel 7.1 47.7 19.8 13.1 3.1 1.9 2.3 1.3 3.0 1.9 64.7 34.1Cotton 29.7 33.6 41.6 49.8 2.9 2.1 7.8 7.4 3.6 2.8 14.4 4.3Corn 20.1 23.9 10.1 10.2 7.9 8.5 13.2 13.5 2.6 2.8 46.1 41.1Meat, swine 46.5 50.0 5.8 6.5 0.3 0.5 5.1 6.0 4.3 4.9 37.9 32.0Rice 33.4 30.8 53.9 55.3 4.3 6.1 4.2 3.9 0.3 0.3 3.9 3.5Wheat 17.5 18.0 27.5 29.1 7.2 9.1 5.2 5.3 12.9 11.1 29.7 27.4Soybeans 18.5 29.5 8.0 9.4 0.7 1.2 33.1 33.4 0.6 1.5 39.1 25.0Oil 6.8 11.7 21.1 24.9 3.4 4.0 8.7 9.6 4.9 5.1 55.2 44.7

Source: UNCTAD secretariat calculations, based on World Bureau of Metal Statistics Yearbook 2013; BP Statistical Review of World Energy 2013; and United States Department of Agriculture (USDA), Production, Supply and Distribution online database.

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 55

forgrowth,itisverylikelytoexperienceafurtherdecelerationofgrowthasaresultoflowerexportstodevelopedcountries.Thiscouldinturnhaveastrongnegativeimpactoncommodityprices.However,ifChina succeeds in rebalancing its growth throughanincreaseindomesticconsumption,prospectsforcommoditydemandandpriceswillbebetter.

Favourable demand conditionswould alsodependonthecapacityofotherhighlypopulatedandrapidlygrowingdevelopingcountriestomovetoamorecommodity-intensivephaseofeconomicgrowthand industrialization.This again should be basedon the development of domesticmarkets in largedeveloping countries such as india and indonesia.indeed, the share of the economies that are at thecommodity-intensivestageofdevelopmentdoubledduringthefirstdecadeofthe2000s,andnowrepre-sentsabout44percentoftotalGDP(bloxham,KeenandHartigan,2012).Thefollowingsubsectiontakesacloserlookatthemaindriversofdemandinrapidlygrowingdevelopingcountries,thepotentialsupplyresponseandtheprospectsforcommodityprices.

(a) Forces driving demand for commodities in rapidly growing developing countries

(i) Population and income growth and rising demand for food

Demand for fooddependsonpopulationandincomegrowth.Theworld’spopulationincreasedbyaboutonebillionbetween1999and2012,toreacha total ofmore than7 billionpeople.Developingcountriesaccountedfor95percentofthispopulationincrease, ofwhichChina and india alone contrib-utedaboutonethird.Althoughpopulationgrowthisexpectedtoslowdownoverthenextdecade,globallyitisprojectedtoincreasebyabout600millionupto2020.Developingcountrieswillcontinuetoaccountforthebulkoftheincreaseintheglobalpopulation,thoughthiswillvarybyregion.ThecontributionofdevelopingcountriesinAsiatopopulationgrowthisexpectedtodecreasefrom58.6percentin1999–2012to51.2percentin2012–2020.China’scontributionissettofallfrom11.5percentto5.7percent,whilethatofindiashouldremainstableatabout22percent.Africa’s contribution is expected to increase from27.6percentto34.4percentoverthesameperiod,whilethatoflatinAmericaislikelytoremainstableataround8percent(UNCTADstat).4Thegrowing

populationimpliesagreaterdemandforfood,espe-ciallybecausetheshareoffoodintotalhouseholdexpendituresishigherindevelopingcountriesthanindevelopedcountries.Thiswillrequireanincreaseinfoodproduction.

Demand for specific food items is stronglydetermined by the evolution of incomes and liv-ingstandards.At low levelsofpercapita income,income growthmainly translates into increasedcalorie intake,and it isprimarily theconsumptionofstaplefoodssuchasriceandwheatthatwillrise.Furtherincomegrowthistypicallyassociatedwithashiftindietaryconsumptionpatterns.Consumersdemandfoodwithhighernutrientandproteincontent,includingmeatanddairyproductsandfruitandveg-etables(TDR 2005,chap.ii).AccordingtotheFoodandAgricultureorganizationoftheUnitedNations(FAo,2012a:17),betweentheearly1990sandtheendofthepastdecade,thesharesofcereals,rootsandtubersdeclinedsignificantlyworldwide,whereasthesharesoffruitandvegetablesandanimalproducts,includingfish,increased.However,theevolutionofdietarychangesdivergedamongregions.Theshareof cereals increased inAfricawhile it declined inAsia.bycontrasttheshareofmeatwassignificantlyhigherinAsiaandlatinAmerica.inChina,duringthe period 2000–2010, total expenditure on fooditems continued to increase but its share in totallivingexpenditurecontinuedtodecline.Percapitaconsumptionofstaplefoods,mainlyriceandwheat,followedadecliningtrend,whilethatofhighervaluefoods,especiallyfoodsofanimalorigin,increased(Zhouetal.,2012).

Unlikeforothercommodities,thedirectimpactofdemandforcerealsinChinaonglobaldemandandimportsofcerealsislikelytohavebeenmodest,par-ticularlyforrice(table2.1).Apartfromthedeclineinpercapitacerealconsumption,Chinaandindiahavebeenpursuingapolicyofself-sufficiency.Thereforetheirinfluenceonglobalmarketshasbeenlimited.However,theincreaseinChinesegrainimportssince2010, as reported inUNComtrade statistics,mayindicate that the country’s self-sufficiency policyisreachingits limits.5ThemostsignificantimpactofChinaonglobalfooddemandisinsoybeans,asbothChineseconsumptionandimportsofthiscom-modity have increased significantly over the pastdecade.Demandforsoybeansusedasanimalfeedincreasedas a result of highermeat consumption.Demand formeat inChina increased by 27.3 per

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centbetween2002and2010,sothattwiceasmuchmeatisconsumedinChinaasintheUnitedStates.overthesameperiod, theconsumptionofmilkinindia increased by 43.7 per cent (brown, 2012).Higherdemandforanimalproductsexertsincreasedpressureontheproductionoffeedstock.Whiletheamountofgrainfedtoanimalsdependsonfarmingtechniquesandtheefficiencywithwhichvariousani-malsconvertgrainintoprotein,whichvarieswidely,ittakesseveralkilosofgraintoproduceonekiloofmeat.Generally,thesetrendsarelikelytocontinueoverthenextdecade.Furthermore,theUnitedStatesDepartmentofAgriculture(USDA,2013)projectsasteadyriseinChina’simportsofcorn.

(ii) Intensity of commodity use in the industrialization process

China’sgrowthprocessduringthepastdecadehas been characterized by a high and increasingintensityofuseofcommodities,particularlymetals(i.e.agrowingvolumeofmetalsconsumedperunitofoutput).Thisistypicalofastageofrapidindustri-alization,whereinmetalsareincreasinglyrequiredasinputforgrowingmanufacturingactivities,includingtheproductionofconsumerdurablestomeetrisingdemand, and for the construction of housing andphysicalinfrastructure.Atacertainpoint,thisinten-sityofuseshouldstarttodecelerateastheservicessector grows in importance and contributes to anincreasingshareoftheeconomy.Thus,intensityofusetendstofollowaninvertedU-shapedpatternaspercapitaincomerises:itfirstrisesastheeconomymovesfromagriculturaltomanufacturingactivitiesandthenfallswithanincreasedparticipationofser-vices(TDR 2005,chap.ii).

itmaywellbethattheintensityofuseofsomemetalsinChinaisclosetoreaching,orhasalreadyreached,itspeak,andthereforeshouldbeexpectedtoslowdowninthenextfewyears,asarguedbysomeobservers (e.g.Nomura, 2012).However,China’spercapitaconsumptionofmetals isrelativelylow(Farooki andKaplinsky, 2012).This implies thatmetal consumption could remain robust, althoughitmightgrowataslowerpace.Moreover,althoughChina’sGDPgrowth isexpected toslowdown, itcould continue to have a considerable impact onglobalmarkets, given the size of this economy.Givenitshighratesofgrowthoverthepastdecade,thesizeoftheChineseeconomyin2012wasmuchlargerthanitwasintheearlyyearsofthecommodity

boom.Therefore,evenataGDPgrowthrateof7or8 per cent,Chinamight have a similar impact oncommoditymarketsasitdidinpreviousyearswhenitgrewataround10percent(seealsoCbA,2012).

AmajorreasonfortheincreasingintensityofmetaluseinChinaisthatitsrapidindustrializationandgrowth,alongwithurbanization,havebeensup-portedbyrisingratesofinvestmentinfixedcapital,particularlyininfrastructureandconstruction.Thesehighrateshavegivenrise tosomeconcernsaboutthe possibility of reaching overcapacity and theemergenceofbubbles,forexampleintherealestatesector.However,itisworthnotingthatitisnotonlythe rate of investment, but also the stockoffixedcapitalpercapita,thatcountsinassessingwhetherinvestmentmaybeexcessive.Someobserversarguethat thestockofcapital inChina isstill relativelysmall(Aglietta,2012).Thus,theintensityofmetaluseislikelytoremainhigh,eventhoughthegrowthrebalancingprocessmayresultinanadjustmentoftheinvestmentrate.Moreover,astherebalancingprocesswillnotbeaccomplishedovernight,eventualchangesincommoditydemandarelikelytobegradual.

inaddition,onbalance,anypotentialnegativeimpactofthegrowthrebalancingprocessinChinaonglobalcommoditydemandwilllargelydependontheextenttowhichdemandfromotherrapidlygrowingdeveloping countries rises.Anumber of countrieswhich so far have exhibited a lower intensity ofuseofmetals thanChinacouldmove toagrowthphase involving theirmore intensive use. if largeandhighlypopulated countries, suchas india andindonesia,weretofollowChina’sindustrializationpathofthelastdecade,prospectsforthedemandformetalscouldremainrobust.Asitisunlikelythatthisdemandwillbebasedonexportstodevelopedcoun-triestothesameextentashasbeenthecaseinChinaoverthepasttwodecades,muchwilldependagainontheexpansionofdomesticdemandindevelopingcountries.overall,infrastructureneedsremainhighinChinaaswellasinotherrapidlygrowingdevelop-ingcountries,apointthatisbrieflydiscussedinthenextsubsection.

(iii) Urbanization and infrastructure needs

Structuralchangeandindustrializationprocessesrunparalleltothatofurbanization,asthelabourforcemoves from the agricultural to themanufacturingsectorandthusfromruralareastocities.According

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 57

to estimates by theUnitedNations (UN-DeSA,2012),theshareoftheurbanpopulationinthetotalpopulationinChinarosefrom35.9percentin2000to49.2percentin2010,anditisexpectedtoreach55.6percentin2015and61percentin2020.Thisisstillfarbelowtheurbanizationratesindevelopedcountries,which are projected to increase fromabout75percentintheperiod2001–2010toaround80percentin2020.AccordingtoAglietta(2012),400millionpeoplelivingintheruralareasinChinaareexpectedtomovetothecitiesbetween2012and2030.Furthermore,200newcitiesofbetween1and5million inhabitants are expected to be built todevelopthecentralandwesternareasofthecountry.However,thisprocesswillneedstrategicplanningto be sustainable.The announced speeding up ofreformofthehukou(householdregistration)systemshould help advance the urbanization process.6 inaddition to the construction of housing and otherbuildings,itinvolvesthedevelopmentoftransportinfrastructure,notonlywithinthecitiesbutalsotolinkdifferentcities,aswellasothertypesofservicesinfrastructure needed for the provision of energyandcommunications.berkelmansandWang(2012)expectChinese residential construction to remainrobustforthenextcoupleofdecades.infrastructureneeds are also likely to remain high, extendingbeyondtheprojectslaunchedwiththefiscalstimulusofSeptember2012.

in other developing countries the process ofurbanizationcanalsobeexpectedtocontinuerapidly.TherateofurbanizationindevelopingcountriesinAsiagrewfrom35.5percentin2000to42.6percentin2010,andisprojectedtoreach49.1in2020.inAfrica,therespectiveratesofurbanizationfortheseyearsare35.5,39.1and43.1percent.UrbanizationratesinlatinAmericaaremuchhigher,atlevelsclosetothoseofdevelopedcountries.Thusthereisstrongpotentialforanincreaseindemandforcommoditiesbymanydevelopingcountriesinordertomeetthedevelopment needs associatedwith urbanization,particularlyforinfrastructuredevelopment(lawsonandDragusanu,2008).

(iv) Increasing demand for energy and the fuel-food linkage

Asnotedabove,economicgrowthandindus-trializationinrapidlygrowingdevelopingcountriesareenergyintensive.increasingenergyuseisalsoassociatedwith rising living standards.China, for

instance, became the biggest energy consumer intheworldin2010,withitsshareinglobalprimaryenergyconsumptionrisingfrom8percentin1990to20percentin2010(Coatesandluu,2012).Coalis itsmainenergysource,but theshareofcoal inChina’s total energy consumption is expected todeclinewithashifttocleanerenergysources.inthemediumterm,oilislikelytoremainthemainenergysourcefortransportation.indeed,demandforoilfortransportationwill continue to increase inparallelwith rising demand for automobiles inChina andotherdevelopingcountries.WhiletheshareofChinainglobaloilconsumptionandimportsisnotashighasforothercommodities,itaccountsforalargeshareinthegrowthofglobaldemandforoil(table2.1).Demand fromdeveloping countries, led byChinaandindia,hasdrivenglobalenergymarketsoverthelastdecade.Forexample,between2002and2012,demandforoil increasedby44.4percent innon-oeCDcountries,whileitdeclinedby6.4percentinoeCDcountries.Asaresult,theshareofnon-oeCDcountriesinglobaloilconsumptionincreasedfrom39.1percentto49.8percent(bP,2013).AlthoughimprovementsinenergyefficiencyareexpectedtocontributetoacontinueddeclineinenergyuseperunitofGDP,therisingdemandforenergyinrapidlygrowingdevelopingcountrieswillpersistoverthenextfewdecades,thoughatslowerratesthaninthepastdecade(bP,2011).

Surgingdemandforenergy,highoilpricesandthesearchforalternativesourcesofenergytotackleclimatechangehaveboosteddemandforbiofuels.These include ethanol,which is producedmainlyfrommaizeandsugar,andbiodiesel,derivedfromoilseeds. indeed, an increasingproportionof foodcropsarenowgrownforbiofuels,leadingtoincreas-ing competition for different land uses: for food,feedstockforanimalsandfuel,andforagriculturalrawmaterialssuchascotton.Therapidexpansionofbiofuelproductionisconcentratedinafewareas.According to the FAo (2012b), by 2012 ethanolproductionabsorbedover50percentof thesugarcane crop inbrazil and37per cent of the coarsegraincropintheUnitedStates.biodieselproductionaccountedforalmost80percentofthecropsgrownforvegetableoilproductionintheeuropeanUnion(eU).CornusedforethanolproductionintheUnitedStatesreached44.3percentoftotalcornuse,upfromonly12.6percent in2002.7Governmentpolicies,such asmandates and subsidies or other kinds ofsupport,haveplayedaveryimportantroleinpushing

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thisexpansionofbiofuelproduction.Withoutsuchsupport,itisdoubtfulwhethersuchproductionwouldbeprofitableinsomeareasliketheeuropeanUnionand theUnitedStates. it is expected that demandfor feedstock for biofuel productionwill continuetogrowover thenextdecade(oeCD-FAo,2013;USDA,2013).

(b) Supply response

The rapidly growing demand for commod-itiesstartingfromtheearly2000spushedupprices,because,duringthefirstyearsoftheboom,supplywas slow to respond.Theextractive industries, inparticular,whichhadexperiencedalongperiodofunderinvestment,weretakenbysurprise.Themin-ingandoilindustriesarecapital-intensive,anditisonlyafterseveralyearsthatreturnsoninvestmentsarerealized,asittakesalongtimefromtheinitialexplorationuntil amineoranoildeposit actuallybecomes productive.Moreover, increasingly, thissectorisfacingsupplyconstraintsbecausethemoreeasilyaccessibledeposits arebecomingmatureorexhausted.Consequently, exploration is forced tomovetomoreremoteareasordigdeepertofindandextracttheresource.Mineraloregradeshavebeendecreasinganditismoredifficulttoprocessmorecomplexores.inaddition,therehasbeenashortageofsupplyofspecializedlabourinthissector.Addedtothis,productioncostshaverisenasaresultoftheneedtocomplywithincreasinglystringentenviron-mentalrequirements.

overall,theseconstraintsonsupplyandtheris-ingproductioncostshavecontributedtoreducingtheefficiencyofinvestmentintheextractiveindustries.Nevertheless,investmentsinexplorationhavebeenrising significantly over thepast decade, althoughtherewasasetbackin2010–2011thatreflecteddiffi-cultiesrelatedtotheglobalfinancialcrisis.AccordingtotheMetalseconomicsGroup(MeG,2013),globalexplorationbudgetsincreasedfromabout$2billionin 2002 to $21.5billion in 2012.This investmentallowedsupplytoincreaseandevenledtosurplusesinsomemetalsmarkets(Smale,2013).eventhecop-permarket,whichhasbeenparticularlytightoverthepastdecade,ismovingintosurplus.However,inthecurrentuncertainmacroeconomicenvironment,itisunclearwhetherfurtherfinancingforexplorationwillbeforthcoming.Thismaydelayprojects,leadingtolowerproductionoverthenextfewyears.

overcoming supply constraints in the energyandminingsectorsdependsstronglyontechnologicalinnovations.onesuchinnovationisthedevelopmentofhorizontaldrillingandhydraulicfracturingtech-niques(knownasfracking)intheoilandgassector.Such technological advances, achievedmainly intheUnitedStates,havethepotentialtosignificantlychange the global energy landscape.They haveenabled that country to substantially increase itsproduction of oil and gas, and could result in itbecomingtheworld’sleadingoilproducerby2020(ieA, 2012a).Thiswould also reduce theUnitedStates’dependenceonenergy imports,whichcur-rentlymeet around20per cent of its total energyneeds.Consequently,itwouldprovideanadditionalpushtotheongoingeastwardshiftintheinternationaloiltrade.itwouldalsocontributetoreducingglobalimbalances, as energy imports have been amajorfactorcontributingtotheUnitedStatestradedeficitoverthepastfewyears(TDR 2010:chart2.5).Thereare indications that these new developments arealreadyaffectingtheoilexportstotheUnitedStatesofsomemajorAfricanoil-producingcountries,suchasAlgeria,Angola andNigeria.8 it is still unclearwhethertheso-called“USshalegasrevolution”canbereplicatedinsomeothercountries.Moreover,theapplicationofthenewtechnologiesremainscontro-versialonenvironmentalgrounds,mainlywithregardtowaterpollution.9

Agriculturealsofacessignificantsupplycon-straints.Thetwomainwaystoincreaseagriculturalproductionarebyexpandingthecultivatedareaandincreasing crop yields.However, the potential toincrease arable land is limited (FAo, 2011) as istheavailabilityofwaterforagriculture.Andtheseresourcesareparticularlyscarceinthosecountriesthataremostinneedofincreasingtheirfoodpro-duction.Therefore, theotheroption is to improveagriculturalyields.However,thepaceofgrowthofagriculturalproductivityhasbeenslowinginrecentdecades.Theaverageannualrateofgrowthofgrainyieldsdeclinedfrom2.2percentduringtheperiod1950–1990to1.3percentduringtheperiod1990–2011 (brown, 2012).This decline partly reflectsthefailureofdevelopmentpolicyreformsadoptedduringthe1990s,whichledtoaneglectoftheagri-culturalsectorsuchasexpressedbyreducedofficialdevelopmentassistance(oDA)tothissectorandlessgovernment involvement in developing countries,followingstructuraladjustmentprogrammesagreedwiththeinternationalfinancialinstitutions.Amajor

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areaofneglectrelatedtoinvestmentinresearchanddevelopment.indeed,agriculturalproductivitycouldbeincreasedbyreducingproductivitygapsindevel-opingcountries(oeCD-FAo,2013)throughgreaterinvestmentinagriculture.inaddition,higherpricesofenergyandother inputcosts,suchasfertilizersandpesticides,haveactedasadditionalconstraintsonagriculturalproduction.

Thesupplyoffoodandotheragriculturalprod-uctsisalsohighlydependentonweatherconditions,whichcontributetoshort-termpricevolatility.Forexample, a severedrought in theUnitedStates inthesummerof2012adverselyaffectedtheproduc-tionofgrainsandsoybeansleadingtoathirdpricespike since the global food crisis in 2008.Thereare also increasing concerns about the impact ofclimate change on agricultural production. Someof theweather-related disruptions in food supply,their higher frequency, and the slower growth ofagriculturalyieldsmightpartlybeassociatedwithclimate change. indeed, some observers suggestthatclimatechangemayposethegreatestthreattoagriculturalproductionandfoodpricesinthefuture(oxfam,2012).10

4. Commodity prices: prospects

Projectionsabouttheevolutionofcommodityprices are particularly challenging given the highlevelofuncertaintyinthecurrentglobaleconomicenvironment.Themineralsandmetalssectorfacesthegreatestdownsiderisksduetonewsupplycom-ingonstreamjustwhendemandgrowthfromChinaappearstobedecelerating.However,asupplycrunchmay reappear in a fewyears time.Regarding theoil sector, specializedenergyagenciessuchas theinternationalenergyAgency(ieA)andtheenergyinformationAdministrationoftheUnitedStatesseeoilpricesfallingtoslightlylowerlevelsthanthoseof2011–2012,butneverthelessremaininghistoricallyhigh.inspiteofstillrisingdemandfromsomeoftherapidlygrowingdevelopingcountries(althoughataslowerpace),marketconditionsshouldeasesome-whatduetorisingsuppliesofnon-conventionaloil.However,theproductioncostsofthesenewsuppliesmake themprofitableonlyat relativelyhighpricelevels.inaddition,theorganizationofthePetroleum

exportingCountries(oPeC)willlikelycontinuetobeakeyforceininfluencingoilprices.Non-oeCDcountriesareexpectedtoremainthemajorsourcesofanyincreaseinoildemand.indeed,oildemandfromthesecountriesisexpectedtoovertakethatofoeCDcountriesby2014(ieA,2012b).

Theoutlookfortheagriculturalsectorpointstoelevatedprices.According tooeCD-FAo(2013),agriculturalcommoditypriceshavebecomestruc-turallyhigher,andareprojectedtoremainfirmoverthenextdecade.Thiswouldbeduetoacombinationofslowerproductiongrowthandstrongerdemand,including for biofuels, as well as a supportivemacroeconomic environment.ethanol productionisexpectedtoincreaseby67percentandbiodieselproductionbyevenmore,butfromalowerbase.by2022,biofuelswillaccountforagrowingshareoftheglobalproductionof sugarcane (28percent),vegetableoils(15percent),andcoarsegrains(12percent).on the supply side, growth of agriculturalproductionisexpectedtoslowdownfromanaver-agerateof2.1percentin2003–2012to1.5percentin2013–2022.GlobalprojectionsbyUSDA(2013)similarlysuggestthat,followingnear-termdeclines,pricesforcorn,wheat,oilseedsandmanyothercropsaresettoremainathistoricallyhighlevels.

bearing inmind that forecasting commoditypricesisadifficulttask,particularlyinthecurrentglobaleconomiccontext,apossiblescenariothatcanbederivedfromtheabovediscussionisthat,owingtoslowinggrowthwhichcouldsomewhatdampenthestrongdemandinChina,commoditypricesmaynotriseasfastastheyhavedoneinthepastdecade.Allowingforsomedownwardadjustmentsintheshortterm,commoditypricesshouldstabilizeatahighplat-eauincomparisonwiththepricesoftheearly2000s.

Therearethreemainviewpointsaboutthepros-pectsforthecommoditysupercycle:

• Themost optimistic observers hold that theexpansionaryphaseofthesupercyclestillhasmanyyearstorun,asChinawillcontinuealongan intensive growth trajectory (Farooki andKaplinsky,2012;Coatesandluu,2012).Thiswillcausecommoditypricestoremainfirm.

• othersarguethatcommoditypriceshaveentereda calmer andmore stable phase of growth,butwillneverthelessremainatrelativelyhigh

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levelsora“newnormal”(bloxham,KeenandHartigan,2012;GoldmanSachs,2012).

• Yetothersbelievethattheexpansionaryphaseof thesupercyclehascometoanend(CreditSuisse,2013;Citi,2013).

However,thereseemstobeoverallagreementthattherewillnotbeapermanentcollapseofcom-modity prices or a quick return to a long-running

deteriorating trendover the next fewyears.Thus,exporters of primary commoditiesmay be lessadverselyaffectedbysystemicchangesintheworldeconomythanexportersofmanufactures.Aslongascommoditypricesremainatrelativelyhighlevelsandcommodityproducersareabletoappropriateafairshareoftheresourcerents,themainchallengeforpolicymakerswillbetoensurethatrevenuesaccruingfromnaturalresourceexploitationspurproductionandexportdiversification.

Severalstudieshaveexaminedproduct-specificpatternsrelatingtothesharpfallinworldtradethatoccurredbetweenthethirdquarterof2008andthefirst quarter of 2009 (e.g.bems, Johnson andYi,2010;levchenko,lewisandTesar,2010;Gopinath,itskhokiandNeiman,2012).Thesestudiesindicatethat:(i)tradeingoodsfellmorethantradeinservicesandthattradeindurablegoods(suchasautomotiveproductsandindustrialsupplies)fellmorethantradeinnon-durablegoods;(ii)thesharpfallinconsumerdurables and other differentiated goods (brandedmanufactures)was entirely in terms of volume,withnoprice reductions; and (iii)declines in realfinalexpenditurewere responsible formostof thecollapse of international trade in 2008–2009 (e.g.bems, Johnson andYi, 2013).The latter findingsuggeststhatchangesinthepatternofinternationaltradeofmanufactures in2008–2009maybemorethanashort-termphenomenon.Thehighprobabilityof continued slowgrowth in developed countries’finalexpenditureinthecomingyears,duetoapro-longedslowdownintheirgrowthrates,islikelytohaveanegativeimpactontheexportopportunitiesofdevelopingcountries.11

ThesepotentialadverseeffectsmaybeassessedbyexaminingtheimpactofdecliningimportsbytheUnitedStates.Thisisbecausethesizeablecontribu-tion to global growth of rapidly rising consumerdemandintheUnitedStateswasamainfeatureofthepre-crisisglobaleconomy.Asdiscussedinsome

detail inTDR 2010,chap. ii,prior to theonsetofthe current economic andfinancial crisis,UnitedStates personal consumption, amounting to about$10trillion,representedaround70percentofthatcountry’sGDPandabout16percentofglobalGDP;consumerspendingalsoaccountedforover70percentofUnitedStatesGDPgrowthduringtheperiod2000–2007.Mostimportantly,importsofconsumergoods,includingautomobiles,accountedforabout85percentoftheincreaseintheUnitedStates’non-energytradedeficitbetween1997and2007.overthesameperiod,importsofnon-foodconsumergoods,excludingautomobiles,increasedbyabout150percent,boostingaggregatedemandintherestof theworldbyalmost$300billioninabsoluteterms.

United States imports of consumer goods,especiallythenon-foodcategories(excludingauto-mobiles), became sluggish in 2008 (chart 2.4).betweenthefirstquarterof1999andthethirdquarterof2008,theseimportsgrew,onaverage,byalmost2 per cent per quarter, before declining sharply.Theythenexperiencedarebound,startinginthefirstquarterof2009,buthavestagnatedattheirpre-crisisleveloverthepasttwoyears.

if imports of non-food consumer goods bytheUnited States are disaggregated into durable(excluding automobiles), semi-durable and non-durablegoods,12thereisaclearindicationthatthelossofimportdynamismintheUnitedStatesmatters

C. Volume effects on exporters of manufactures

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for developing countries’ export opportunities(chart2.5).Thedurableconsumergoodscategory,wasthemostdynamicofthethreeproductgroups,withUnitedStates imports tripling between1997and2007.GiventhatChinaandMexicocombinedaccountedfor60percentofUnitedStatesimportsofsuchgoodsin2012,astagnationofdemandintheUnitedStatesatbelowpre-crisislevelscouldhaveamajor impact on these two exporting countries.ChinaaccountsformorethanhalfofUnitedStatesimports of semi-durable consumer goods,whichcontinuestobethelargestamongthethreeproductcategories inspiteof thedeclineof itssharefromover60percentin1995toabout45percentin2012.Non-durableconsumergoods(amajorcomponentofwhichispharmaceuticals)istheonlycategorythathasmovedrapidlybacktoitspre-crisisdynamism.However,developingcountriesaccount foronlyasmallshareofUnitedStatesimportsofthisproductcategory.13Taken together, this evidence suggeststhattransmissionoftheeconomicslowdownthroughthetradechannelhasadverselyaffecteddevelopingcountries’ exports of products such as apparel

and household equipment to developed countries.Those exports had boosted growth in developingcountriespriortothecrisisandsupportedproductivetransformation.

Anexaminationofdatafromtheeurozonesup-portsthisfinding.Followingadeclinein2008–2009,euro-zoneimports(excludingintra-euro-zonetrade)ofdurable(excludingautomobiles),semi-durableandnon-durableconsumergoodsreboundedrapidly,andby2010–2011theyhadbeguntoexceedpre-2008levels.However, thegrowth rate of these importsremains considerably lower than in the pre-crisisperiod: imports of semi-durable consumer goods,which representmore than two thirds of the eurozone’s total imports of all these product groups,recordedanaverageannualgrowthrateof12percent(andagrowthrateof23percentfromChina,whichisbyfarthemostimportantdeveloping-countrysource,accountingforalmosthalfoftheeurozone’stotalimportsofthisproductcategory)duringtheperiod2002–2007,butonly10percent (8percent fromChina)duringtheperiod2009–2011.

Chart 2.4

UNITED STATES IMPORTS, SELECTED CONSUMER GOODS CATEGORIES, 1st qUARTER 1999–4th qUARTER 2012

(Billions of dollars)

Source: UNCTAD secretariat calculations, based on United States Bureau of Economic Analysis, International Data, table 2a.Note: Data for 2012 fourth quarter are preliminary estimates. The trend growth rate for imports of automobiles is 0.6 per cent per

quarter, while that of non-food consumer goods is 1.8 per cent per quarter.

0

20

40

60

80

100

120

140

160

1999 2001 2003 2005 2007 2009 2011

Automobiles (vehicles, parts, and engines)

Non-food consumer goods, except automobiles

Trend I/1999–II/2008: automobiles (vehicles, parts, and engines)

Trend I/1999–II/2008: non-food consumer goods, except automobiles

20122000 2002 2004 2006 2008 2010

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The possibility of changing rapidly from anexport-oriented growth strategy towards amoredomestic-demand-orientedonedepends largelyonwhatextentthesectoralstructureofdomesticproduc-tionisdelinkedfromthatofdomesticdemand.Suchadissociationwillbeparticularlystrongincountriesthatexportalargeproportionofprimarycommod-ities.However,itwillalsobesubstantialforothercountriesthatproducesophisticatedgoodsforexportsdestinedforaffluentconsumersindevelopedcoun-tries,butwhichfewdomesticconsumerscanafford.

Natural-resource-rich economies have longattemptedtoweakenthisdissociationbydiversifying

their sectoral structure of production through anincrease inmanufactures. in thosedevelopingandtransitioneconomieswheremanufacturesconstituteasizeableshareofproductionandexports,thelinkbetween the sectoral composition of productionandthatofexportsmaywellbestrengthenedbyanincreasinglyglobalizingeconomyinwhichdomes-ticdemandindevelopingandtransitioneconomieswillhaveagreaterweightinglobaldemand,outputandtradepatterns.Theensuingchangeintheshapeof the global distribution of consumption,with asmaller share of consumption by rich consumersandalargersharebylowerandmiddle-incomecon-sumers,implieschangesinpreferencesandawider

Chart 2.5

UNITED STATES IMPORTS OF CONSUMER GOODS (ExCL. FOOD AND AUTOMObILES), by CATEGORy AND SELECTED SOURCE COUNTRIES, 1995–2012

(Billions of dollars)

Source: UNCTAD secretariat calculations, based on UN Comtrade.

0

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120

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1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Durable goods, totalDurable goods, ChinaDurable goods, Mexico

Non-durable goods, totalNon-durable goods, China

Semi-durable goods, total (right scale)Semi-durable goods, China (right scale)

D. Towards more domestic-demand-oriented growth strategies

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 63

varietyofnewspendingpatterns.This,inturn,willguideinvestmentdecisionsandleadtochangesinthesectoralfocusofinvestment,withensuingchangesinthecompositionofdomesticproductionandoutput.

SomeoftheissuesassociatedwithachangeingrowthstrategiestowardsagreaterroleofdomesticdemandmaybeillustratedbytheexperienceoflatinAmericaneconomiesfollowingtheGreatDepression(box2.1).Theremainderof thissectionexaminesissuesrelatedtothedivergencebetweenthesectoralstructureofexportsand thatofdomesticdemand,focusing on the balance-of-payments constraint.This is followedby an analysis of changes in theproduct composition of domestic demand as percapitaincomesrise.

1. Domestic-demand-oriented growth and balance of payments

Growthdynamicsinducedonthedemandsidesituncomfortablywithmostoftheexistinggrowththeories, whether neoclassical or endogenous.These theoriesconcentrateon thesupplysideandneutralize demand effects on long-term growthbyassuming that theevolutionofconsumptionofeach good is proportional to income growth (i.e.changesinpercapitaincomehavenoeffectonthecompositionofproductbaskets).14bycontrast,earlydevelopment economists (e.g.Rosenstein-Rodan,1943)emphasizedthatdemandgrowthforaspecificgood,and theensuinggrowingsizeof themarketforthatgood,leadtoincreasinginternalreturnstoscaleinproducingthatgood.largermarketsboostproductivityeitherbecauseofeffectsstemmingfromlearningbydoing(Matsuyama,2002;DesdoigtsandJaramillo,2009)orthroughinnovationsthatallowthedevelopmentofnewmethodsofproductiontosatisfythe risingnewdemands (FoellmiandZweimüller,2006and2008).

Theresultingscaleeconomiesenablethegoodstobeproducedatlowercosts,tothebenefitofeitherconsumersorotherindustriesthatusethosegoodsasinputsinproduction.Asthesegoodsbecomeafford-abletoanincreasinglylargenumberofhouseholdsandindustries,themarketsforthesegoodsexpand.This,inturn,induces“furtherimprovementinprod-uctivity, creating a virtuous circle of productivity

gainsandexpandingmarkets” (Matsuyama,2002:1038).15buttheproductivitygrowthassociatedwithincreasingeconomiesofscalemayalsobeusedforpayinghigherwages,ratherthanforreducingprices.Thedemandgrowthstemmingfromhigherwagesenlargesthesizeofthedomesticmarketsforgoodsandservices,whichenablesscaleeconomiestospillover awide range of industrial sectors.Murphy,Shleifer andVishny (1989) developed this insightfurther, showing that such complementarities ofdemandworkvia thebuyingpowerof themiddleclass,which eventually determines the extent ofhorizontal complementarities across all industriesoftheeconomy.16Theseconsiderationsbecomeevenmorerelevantforadevelopmentstrategythatgivesgreaterimportancetodomesticdemandgrowththaninthepast.Moreover,forsuchastrategytobesuc-cessful,itwouldalsoaimatboostingthepurchasingpowerofincomegroupsbelowthemiddleclass,sothattheremaybescopeforeconomiesofscaleinanincreasingnumberofsectorsandfirmsthatproduceprimarilyforthedomesticmarket.

However,ifagrowingmarketsizefailstotrig-gerproductivitygains, the two-waycausalitymaywellcausethedomesticeconomytostagnate.Thismayhappeninanopeneconomywherethemarket-sizeexternalitieslinkedtoincreasingeconomiesofscale benefitmainly foreign producers (Murphy,ShleiferandVishny,1989;DesdoigtsandJaramillo,2009).inthiscase,thepaceofindustrialmoderniza-tionmaybeconsiderablyreduced,becausedomesticproducerswillcontinuetoconcentrateonsupposedlytechnologically simple goods (such as food) thatsatisfy necessities,while the growingmarkets formorecomplexgoods(suchascarsandaudio-visualproducts)willbecapturedbyforeignproducers.

indeed,totheextentthatacceleratedspendingstemmingfromdomesticdemandissatisfiedthroughimports,withoutacomparableexpansionofexports,thegrowthprocessof thedomesticeconomymaywellfaceabalance-of-paymentsconstraintandgrindtoahalt.Accordingtothedynamicanalogueoftheforeign trademultiplier first presented byHarrod(1933),therateofdomesticoutputgrowthdependsontherateofgrowthofexports,whichinturndependsontheincomeelasticityofdemandforexportsandthegrowthrateofworldincome,aswellasonthecountry’sincomeelasticityofdemandforimports.17Prebisch (1950) applied this relationship to thedevelopmentcontext,arguingthatsustainedgrowth

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Box 2.1

A ShIFT IN DEVELOPMENT STRATEGIES: LESSONS FROM ThE LATIN AMERICAN ExPERIENCE AFTER ThE CRISIS OF ThE 1930sa

Withthechangingpatternsofinternationaldemand,developingcountriestodayarefacedwiththeissueofwhethertoshifttheirdevelopmentstrategiesbygivinggreateremphasistodomesticdemandtodriveeconomicgrowth.butitisnotthefirsttimeineconomichistorythatthisimpulsetoshifttodomestic-demand-orientedgrowthhasarisen:theGreatDepressioninthe1930sevokedasimilarresponsefromlatinAmericancountries,whichadvancedtheprocessofindustrialization.

beginninginthe1870s,afteralongperiodofpoliticalinstabilityfollowingtheirindependence,mostlatinAmericancountriesbeganaprocessofrapidintegrationintotheglobaleconomyasexportersofprimarycommoditiesandimportersofmanufacturesandforeigncapital.Theyalsoattractedlabourmigration,whichcontributedtodiversifyingthepatternofdomesticconsumption.Theexpansionofexportsspurredeconomicgrowth,whichinturngeneratednewresourcesfortheirgovernments,consolidatednationalStatesandcontributedtogreaterpoliticalstability.However,thisdevelopmentpathdependedheavilyonacontinuousexpansionofdemandforprimarycommoditiesfromdevelopedcountries.italsocontributedtoworseninglivingconditionsoftheoftenlandlessruralpopulationsandfavouredtheriseofaproletariatandurbanmiddleclassthatclaimedbettersocialconditionsandgreaterpoliticalparticipationinwhatwereoligarchicsocialandpoliticalstructures.

Thevulnerabilityofsuchadevelopmentpathbecameevident,initiallywiththeFirstWorldWarwhichdisruptedtradeandcapitalinflows.Thereafter,theGreatDepressionthatbeganin1929ledtoacollapseofprimary commodity exports and, as a consequence, to a severe contractionof imports andfiscalrevenues,aswellassovereigndebtdefaultsbymostcountriesintheregion.inthesecircumstances,which in some countrieswere further complicated by political crises, governments set aside theirformerliberalcredoandadoptedmorepragmaticandinterventionistpolicies.Theyabandonedthegoldstandardandestablishedforeignexchangecontrols,andintroducedquotasonimportsandraisedimporttariffs.Currencydevaluationsandimportrestrictionsimprovedrelativepricesofmanufacturesatatimewhenthecapacitytoimportsuchgoodshaddiminishedsignificantly.Thenewlycreatedcentralbanks,whichsupportedthedomesticbankingsystem,coveredthefinancialneedsoftheprivateandthepublicsectors.Thesemeasuresenabledtherapidexpansionofdomesticproductionofmanufactures,whichprogressivelyreplacedimports,settinginmotionaprocessthatcametobeknownasimportsubstitutingindustrialization(iSi).industrialproductiongrewmostnotablyincountriesthatalreadyhadmanufacturingcapabilitiesandwhosegovernmentssupporteddomesticdemand.between1929and1947,theshareofmanufacturinginGDPincreasedfrom22.8to31.1percentinArgentina,from11.7to17.3percentinbrazil,from7.9to17.3percentinChile,from6.2to11.5percentinColombiaandfrom14.2to19.8percentinMexico(Furtado,1976:137).

AftertheSecondWorldWar,theiSiperiodcametoanend:industrializationcontinuedtorelyprimarilyondomesticmarkets, but increases in domestic production ofmanufactured goodswere no longerbasedonthesubstitutionofpreviouslyimportedgoods,whichhadbeenreducedconsiderablybythattime.instead,arapidexpansionofdomesticdemandbecamethedrivingforcebehindoutputgrowthanddomesticinvestment.industrializationand,concomitantly,urbanizationincreasedtheinfluenceofthelocalbourgeoisie,themiddleclassandindustrialworkersintheeconomyandinnationalpolitics.Theresultingpoliticalchangebroughtwithitadeliberatereorientationofdevelopmentstrategy,which,by introducing long-termdevelopmentprojects, aimedatmodernizing theproductiveapparatusandstrengtheningeconomicandsocial integration.Domesticdemandwasnurturedbothbyurbanizationandtheprocessofindustrializationitself,whichexpandedemploymentinthemodernsectors.inseveralcountriesmoreequalincomedistributionalsoboosteddemand.Hence,thekeyelementsofthatstrategy(industrializationandtheexpansionofdomesticmarkets)supportedeachotherinavirtuouscircle(SainzandFaletto,1985).

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 65

in this context, the economic role of theStatewas greatly expanded. it fostered industrialization,infrastructurebuilding and thedevelopmentof domesticfirms through severalmeans. inChile, theProductionDevelopmentCorporation (CorporacióndeFomentode laProducción),created in1939,developedbasicindustries;inbrazil,theGovernmentsupportedindustrythroughtradeprotectionandthecreationofState-ownedfirms(e.g.thesteelproducerVoltaRedonda);Mexiconationalizeditsoilindustryin1938andsupporteditsmanufacturingsectorthroughtheindustrialPromotionAct(1946)andStateprocurement;inArgentina,theStatecapturedmostoftherentsfromagriculturethroughitscontrolofforeigntrade,andnationalizedthetransportsystem,andcommunication,powerandsanitationservices(previouslyownedbyforeigninvestors),whilethecentralbankandState-ownedbanksextendedcredittoindustrialactivities;inVenezuela,theStateacquiredmostoftheoilrentandcreatedtheVenezuelanProductionCorporation(CorporaciónVenezolanadeFomento)forsupportingthesteelandagro-industrialsectors;whileboliviaalsonationalizeditsoilsector(1937),andlater its tinproduction(1952),andimplementedagrarianreforms(1953)(Thorp,1997).

Thisreorientationofdevelopmentstrategy,triggeredinitiallybythecrisisofthe1930s,continuedtopromoteeconomicgrowthafter theSecondWorldWar.latinAmericagrewrapidly in thepost-waryears,withitsGDPgrowingatanaverageannualrateof5.4percentbetween1950and1975,ledbythemanufacturingsector(6.8percent).by1975,theshareofmanufacturesinitsGDPexceeded25percent(eClAC,1978),whiletheproportionoftheurbanpopulationrosefrom42percentin1950to62percentin1975.Themanufacturingsectoralsobegantodiversify,withproductionevolvingfromlabour-intensiveconsumergoods todurableconsumergoods, industrial inputsandcapitalgoods.by1965,technology-orscale-intensiveindustriesaccountedforaround50percentofmanufacturingproductionintheregion’slargesteconomies:Argentina,brazil,Chile,Colombia,MexicoandPeru(eClAC,1979).Theinternationalenvironmentwasalsoconducivetotheregion’seconomicdevelopment,asforeignmarketsregainedmomentumduringthe1960sandforeigndirectinvestment(FDi)inmanufacturingcontributedtothediversificationofindustrialproduction.

However,thereweresomedrawbackstothisdevelopmentstrategy,asevidencedbyrecurrentimbalancesinthebalanceofpaymentsandpersistentinflation.Theseweretheresultofstructuralfactors(e.g.rigiditiesonthesupplyside,demandelasticitiesofimportsandexports, leadingtotradedeficitsandfrequentdevaluations;andsocialtensionsrelatedtoincomedistribution)ratherthanflawedmonetarypolicies(Noyola,1957;bajraj,1977).Retrospectivecomparisonwith theeastAsian industrialdevelopmentexperiences suggests that themainproblem inlatinAmericawas related to the fact that therewascomprehensive, rather than selective andwell-targeted, protectionismof domestic industries, andgovernmentsupportwasnotlinkedtoperformancerequirements(includingthoserelatedtoexportsofmanufactures).bythebeginningofthe1970s,anewphaseoftheindustrializationprocessseemedtobetakingplaceinthemoreadvancedlatinAmericancountries,whichtargetedmorediversifieddomesticandexternalmarkets.Thisphasewascharacterizedbyhighinvestmentandrapideconomicgrowth.However,strongfinancialshocksandradicalpolicyreorientations,especiallyafterthedebtcrisisoftheearly1980s,broughtthisdevelopmentpatterntoanabruptend.

Thisexperiencesuggeststhat,whileitispossibletoanchorindustrializationindomesticdemandgrowth,theprocessofstructuralchangesneedstobecarefullymanagedonboththedemandandthesupplyside.Moreover,thepursuitofsuchadevelopmentstrategyneedstobeaccompaniedbymacroeconomicandfinancialpoliciesaimedatkeepinginflationlowandpreventinglargeexternalimbalancesandfinancialinstability.

a ThisboxdrawsonCalcagno,2008.

Box 2.1 (concluded)

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in developing countries requires industrialization;otherwise,growthwillbeheldback.Thereasonisthatanunsustainablecurrent-accountdeficitemergeswhentheincomeelasticityofdemandforprimarycommodityexportsinworldmarketsislowerthantheincomeelasticityofdemandforimportedgoodsneededbydevelopingcountries.

Although the global economic context hasevolved, themechanisms highlighted byHarrod(1933)andPrebisch(1950)continuetoapply:ifaprolongedeconomicslumpindevelopedcountriesleads to a decline in developing countries’ exportearnings,thelatterwillfinditdifficulttosustainahighrateofgrowthiftheneedtosatisfyacceleratingexpenditure in the various domestic-demandcomponentstriggersasurgeofimports.However,ifthereweretobeanexpansionofdemandinseveraldeveloping-country trade partners simultaneously,they could constitute amarket for each other,and therefore reduce their balance-of-paymentsconstraint.Consequently, regional integrationand,moregenerally,South-Southtrademaybenecessarycomplements to domestic-demand-led growthstrategies.

Theimportintensityofthethreecomponentsof domestic demand (i.e. household consumption,government expenditure and investment) varieswidely, andgenerallydiffers from the importanceof the three components in aggregate demand.Household consumption usually accounts for byfarthelargestshareofaggregatedemand,whereas“importstendtobestronglycorrelatedonaveragewithexportsandinvestmentand,toalesserextent,privateconsumption,whiletheyappeartobeuncor-relatedwithgovernmentconsumption”(bussièreetal., 2011: 10).Moreover, the correlation betweenimportsandhouseholdconsumptionisparticularlyhighduringperiodsofrecession.

Thesefindings, relating to differences in theimport intensity of the different components, arebasedonananalysisofalmostonlydevelopedecono-mies.However,thereislittlereasontobelievethatthepatternswilldiffertoanysignificantextentindevel-opingcountries.Thecorrelationbetweendomesticdemandgrowth and imports of capital goods anddurable consumer goods in developing countriesprobablyexceedsthatindevelopedcountries.but,the

importintensityofexportsisprobablyalsohigherindevelopingcountries,especiallythosewhoseexportsectorsarecloselyintegratedintoglobalproductionchains.indeed,roughcalculationsreveallittledif-ferencebetweendevelopedanddevelopingcountriesinthepatternofimportintensityacrossthevariouselementsofaggregatedemand(Akyüz,2011).

if the sectoral composition of domestic pro-ductionwereadjusted tobettermatch thesectoralstructureofacceleratingdomesticdemand,itwouldreducetheimportcontentofthatgrowingdemand.itwouldalsoallowdomesticentrepreneurstoben-efitfromincreasingreturnstoscaleandencouragethemtoengageininnovativeinvestment.Thiswouldalsocreatenewemploymentopportunities.Forthedomestic economy, itwould imply an increase innominal incomes,whichwould induce domesticconsumers to increasingly engage indiscretionaryspending.Globally, this could trigger a cumula-tiveprocessofincomeandemploymentgrowth,asgrowingdemandwouldspurtheoutputofexistingmanufacturingindustriesaswellasthecreationofnewindustries.ideally,thisprocessshouldtakeplaceonaregionalscale,withanumberoftradepartnersencouragingdomesticdemandinacoordinatedway.Thiswouldboostintraregionaltrade,whichtendstobeintensiveinmanufacturedgoods,therebyenablingeconomiesofscaleandspecialization(TDR 2007).

Thecriticalimportanceofthedomesticmarketfor domestic industrywas stressed long ago byChenery,RobinsonandSyrquin(1986).Theynotedthatgrowthofdomesticdemandaccountsforaboutthreequartersoftheincreaseindomesticindustrialoutput in largeeconomies, and slightlymore thanhalfinsmalleconomies.buildingontheirinsights,HaraguchiandRezonja(2010)showedthatthesharesinproductionofdifferent industrialsectorsfollowasequencewhichresemblesthechangesobservedinthesectoralstructureofdomesticdemand.Thissimilaritycanbeobservedparticularlywithregardto household consumption expenditure in largeeconomies,where the food and beverages sectorisadriverofsustainedgrowthatlowlevelsofpercapitaincome,motorvehiclesatmediumlevels,andaudio-visualproductsathighlevels.Thefollowingsectionprovidesfurtherevidenceofchangesintheproduct composition of consumer demand as percapitaincomerises.

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 67

2. Changes in the product composition of domestic demand

Demand-sidemechanismswhichreflectchangesinthepatternsofdemandaspercapitaincomeriseshaveconstitutedonlyarelativelysmallpartof thelarger search for the stylized facts that character-izeeconomicdevelopment.Thedecliningshareofaggregateconsumerspendingonfood(i.e.aneffectknownas“engel’slaw”)isusuallyconsideredthemost notable feature of suchdemand-side effects.Attemptstogeneralizeengel’slawbyenlargingthescopeofanalysistomorecategoriesofexpenditurehaveoftenfocusedonchangesinthebasketofneces-sities (such as food, housing and clothing),whiletreatingnon-necessities(suchasdurablegoods)asaresidualoflittleimportance(e.g.Houthakker,1957;Chenery,RobinsonandSyrquin,1986).

Socioeconomic class is likely to be a veryimportantdeterminantofindividuals’consumptionpatterns(e.g.lluch,PowellandWilliams,1977).Thereasonisthatpeoplewhoarebetteroffdisposeofdiscretionaryincomeandcanshifttheirconsumptionpattern away from only basic necessities. Thisshift in consumption patternsmay be based on apreferencestructurerelatedtoahierarchyofneeds(Maslow,1954).itimpliesthatconsumerswillstartspendingbeyondgoodsthatonlysatisfytheirbasicorsubsistenceneedsoncetheirincomeexceedsacertainthreshold.Anotherimportantassumptionassociatedwith such a preference pattern is that consumerdemandforanygoodreachesasaturationpoint,sothatdemandgrowthforthatgoodwillslowdownandeventuallyceaseasmoreandmorehouseholdsreachthelevelsofincomethatmarksaturationpoints.18Thethresholdswhichtriggeranaccelerationofdemandforspecificconsumptionitemsclusteratcertainlevelsofpercapitaincome(Mayer,2013).Theselevelscloselycorrespondtowhatistypicallyusedtocharacterizeanindividualasbecoming“middleclass”.

Thereisnogenerallyaccepteddefinitionoftheterm “middle class”.However, in economics andapplied empirical analysis, it is generally used todescribethesocialstatusofindividualswhohaveacertainamountofdiscretionaryincomeattheirdis-posalwhichallowsthemtoengageinconsumptionpatternsbeyond just the satisfactionof theirbasicneeds, though not – or only occasionally – theirdesireforluxuryitems.Giventhatmanyindividuals

aspiretomiddle-classstatus,individualsidentifyingthemselvesasbeing“middleclass”isalsooftenusedasadefinition.Thismayexplainwhyinterpersonaleffects on consumer demand, such as bandwagoneffects,wherebyeachperson’spurchasingpatternisinfluencedbywhatspecificproductsareboughtbyaproportionofsomerelevantgroupofothers,hasoftenbeenanimportantelementinthediscussionofmiddle-classconsumptionpatterns(e.g.Witt,2001).

The twoboundaries that separate themiddleclassfromthepoor,ontheonehand,andfromtherichontheother,maybedefinedinrelativeorabsoluteterms.Relativeapproachesusequintilesofincomedistribution or a band around themedian of thedistribution.Themaindrawbackoftheseapproachesisthattheydonotpermitinternationalcomparisons,whereastheadvantageofusinganabsoluteapproachisthatitdoespermitsuchcomparisons.Anabsoluteapproachissimilarinspirittointernationalpovertymeasures, and allows the tracing of both the sizeandtheincomeshareofthemiddleclassonaglobalscale.Toensurecomparabilityacrosscountries,suchmeasuresemploypurchasingpoweradjustmentstotranslate income expressed in domestic currencyunitsintoaninternationallycomparableunit(i.e.theinternationaldollar).19

bussoloetal.(2011)haveusedsuchanapproach,wherethetwothresholdsdefiningthemiddleclassaresetasequaltothepercapitaincomesofbrazilanditaly.20Kharas(2010)hasalsousedthisapproachtodefinetheglobalmiddleclassascomprisingindividu-alswhosedailyexpendituresarebetween$10and$100inpurchasingpowerparity(PPP)terms.boththesestudiessetthelowerboundatanannuallevelof per capita incomeof about 4,000 internationaldollars.bycontrast,thedefinitionusedinbussoloetal.(2011)impliesanupperboundofabout17,000internationaldollars,whileKharas (2010) sets theupperboundatabout35,000 internationaldollars.Thesedifferencesintheupperboundarereflectedindifferencesinhistoricmeasuresofthesizeoftheglobalmiddleclass,aswellinitsfutureevolution.bussoloetal.(2011:14)estimatethattheproportionofthemiddleclassinthetotalworldpopulationwillincreasefrom7.9percentin2000to16.6percentin2030,andthatoverthesameperiod,thenumberofpeopleindevelopingcountriesthatarepartoftheglobalmiddleclasswillgrowmorethanfourfold,toexceedonebillion.AccordingtoKharas’(2010:27)estimates, the size of theglobalmiddle classwill

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increasefrom1.8billionpeoplein2009to3.2billionin2020and4.9billionin2030,whichimpliesthattheproportionofthemiddleclassinthetotalworldpopulationwill increase from26percent in2009to41percentin2020and58percentin2030.Asiawillaccountforthebulkofthisincrease,withthenumberofpeoplebelongingtothemiddleclassinthisregionestimatedtogrowsixfold.ChinaandindiawillaccountformorethanthreequartersoftheAsianmiddleclass.ThesizeofthemiddleclassinCentralandSouthAmericawillgrowbyafactorof2.5,whileinsub-SaharanAfricaitwilltriple,yetremainatonly2percentofthetotal;anditwillremainmoreorlessunchangedineuropeandNorthAmerica.21

ofcourse,thesenumbersaremerelyillustrativeandshouldnotbeconsideredexactpredictions.Thetwostudies’projectionsontheevolutionofthemid-dleclassindevelopingcountriesmaybeconsideredoptimisticasanextrapolationofpastdevelopments(e.g. in terms of investment and technologicalchange).Thisisbecausetheydonottakeintoaccounttheunsustainabilityof thepoliciespursuedby thedeveloped countries during the decade precedingtheoutbreakofthecurrentglobaleconomiccrisis,whichprovided the favourable external economicenvironmentthatallowedhighinvestmentratesandtechnological change indevelopingcountries.buttheymay also be considered pessimistic, as theyassumethattheshareofhouseholdconsumptioninGDPremainsconstantovertimeandthat,inthecaseofKharas(2010),growthisdistributionneutral,andthusdonottakeintoaccounttheimpactofpoliciestostrengthendomesticpurchasingpowerandreduceincomeinequality,whichthisReportadvocates.Asdiscussedinsectioneofthischapter,astrategythataccordsagreaterrole todomesticdemandgrowthwill requirea faster increase inwages than in thepast.Thustheremaybeanacceleratedincreaseinthesizeofthemiddleclassifthisstrategyissuccessful.

evidenceonincomedistributionindicatesthatthesizeofthemiddleclass(asdefinedbyKharas,2010) varieswidely across countries (chart 2.6).in 2005,which is themost recent year forwhichcomprehensivedataareavailable,themiddleclassconstituted60percentofthepopulationintheUnitedStates,comparedwithonly30percentinChina,androughly5percentinindia,butabout80percentintheRussianFederation.More importantly for thefutureevolutionofconsumptionexpenditureisthenumberofpeoplethatareataroundtheentrylevel

ofthemiddleclass,wherethenewspendingpatternsstartemerging.Suchincomebracketsarevirtuallyabsent in the developed economies, but comprisemorethanhalfoftheChineseandaboutthreequartersoftheindianandindonesianpopulationsrespectively.

Manydevelopingeconomiescontinuetohavesubstantialpocketsofpovertyandlaggingregions,especially in sub-SaharanAfrica andSouthAsia.Such pockets hamper the expansion of domesticconsumptionofdurable consumergoods.but thisalsoimpliesthatthereisconsiderablepotentialforincreasing the effectivedemand for, anddomesticsupplyof,basicandnon-durablegoods,suchasfood,aswellasotherfundamentalneeds,suchasclothing,accommodation,heatingandlighting,health,educa-tionandsafety(ChaiandMoneta,2012),includingthroughachangeinincomedistribution.

However,manyotherdevelopingandtransitioneconomiescouldwitnessarapidaccelerationofcon-sumptionofdurableconsumergoodsinthemediumterm.Changesindistributionaloutcomesthatcouldlift individuals from the lower incomebrackets tomiddle-classstatusarecloselyrelatedtothecreationofwell-paidjobs.AsnotedinTDR 2012,muchofthedeclineinincomeinequalityinlatinAmericaoverthepast fewyearshasbeendue to thecreationofsuchjobs.Thishascontributedtosomedevelopingcountriesseeing“theemergenceofaworkingmid-dleclass,whichhasnowsurpassed40percentofthedevelopingworld’sworkforce”(ilo,2013:12).

Greaterequalityofincomeiswidelyexpectedtoboosteconomicgrowth,whichwouldprovidethemainimpetustoconsumerspending.indeed,thereisnowbroadagreementthatgrowthaccompaniedbyhighorrisinginequalityisunsustainableinthelongrun,althoughtheremaybetemporaryexceptionsincountrieswithveryrapidgrowthrates,whereabso-lutelevelsofincomemayincreasesharplydespitegreaterincomeinequality.Moreover,highlevelsofincomeinequalitywillholdbackthepaceatwhichsufficientlylargesegmentsofthepopulationattainthe thresholds of per capita income that lead toaccelerateddemand.Thiscouldwellretard,orevenprevent, cumulative processes that drive growththroughassociatedsupplyresponses.

Thediscussioninthissectionimpliesthattheprocess of per capita incomegrowth and/or stepstowards amore equal distribution of income are

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 69

accompaniedbytheemergenceofarangeofinvest-mentopportunitiestoproducegoodsandservicestomeet thenewdemand.These investmentopportu-nitieswillariseatdifferentpointsintimewithrespecttobothindividualproductsandindividualcountries.Productswillvarybecausedemandfordifferentprod-uctswillaccelerateatdifferentlevelsofpercapitaincome.Variationacrosscountrieswillbeduetothedifferentsizeoftheslicesofthepopulationthatarein,

orabouttoenter,themiddleclass,whoseboundariesmarkthelevelsofpercapitaincomewhereproduct-specificdemandelasticitiesareparticularlyhigh.Thecombinationofthesevariationsacrossproductsandacrosscountriescanengenderasustaineddynamicgrowthprocessdrivenbyinteractionsbetweensupplyanddemandovertime.Thenextsectionfocusesontheeconomicpolicyimplicationsoftheseinteractionsbetweensupplyanddemand.

Chart 2.6

PER CAPITA INCOME AND DIFFERENT INCOME CLASSES, SELECTED COUNTRIES, 2005

Source: UNCTAD secretariat calculations, based on Milanovic, 2012.Note: The two horizontal lines are the lower and upper income limits of the middle class. The size of the middle class in each

country is indicated by the respective country line that is within the shaded section.

2.5

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Income distribution deciles within countries

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Russian Federation

Nigeria

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The preceding sections of this chapter have examined the adverse impacts of slow growth in developed countries on the export opportunities of developing and transition economies. They have emphasized that the reduced export opportunities are likely to concern mainly those countries that export a large proportion of manufactures to devel-oped countries. These countries therefore need to reconsider their growth strategies, giving greater emphasis to domestic sources of demand growth and South-South trade.

This section discusses possible policies that developing and transition economies could adopt in pursuit of such a strategy. It first looks at changes in the relative importance of the domestic demand segments of GDP following the outbreak of the current global economic crisis. It then focuses on policies aimed at: (i) increasing domestic demand by fostering domestic purchasing power, lifting the income of domestic consumers, increasing domestic investment and strengthening the impact of public finances on domestic demand; and (ii) promoting domestic productivity growth and structural change with a view to increasing domestic supply capacities of goods in response to rising domestic demand. Finally, this section looks at the implications of the increased importance of developing countries in the global economy for global development partnerships.

During the period 2008–2009, many develop-ing and transition economies reacted to a decline in their net exports by increasing the share of govern-ment consumption expenditure in GDP (chart 2.7). Household consumption expenditure as a share of GDP also increased in some of these countries, such as Brazil, Malaysia and the Russian Federation, while it fell in others, such as China and Indonesia. The latter two countries saw a particularly large increase

in gross fixed capital formation as a share of GDP. In China, for example, this share increased from 39 per cent in 2007 to 45 per cent in 2009. This share also increased, though to a lesser extent, in most of the other economies presented in chart 2.7, many of which are rich in natural resources, such as Chile, Mexico, the Russian Federation and South Africa.

The data for 2011 suggest that there were no similar increases in gross fixed capital formation as a share of GDP, which was possibly a reac-tion to the euro-zone crisis that gained traction in 2011 (chart 2.7). This difference in reaction may be explained by the fact that in 2008–2009 there were expectations of an early recovery, which were sup-ported by episodic signs pointing to a rapid rebound of growth in developed economies. This had led to the assumption of only a temporary decline in otherwise continuously increasing opportunities for exports to these countries. With the euro-zone crisis, by contrast, policymakers in developing and transition economies may have accepted the likelihood of a prolonged period of sluggish growth in developed economies’ aggregate demand, which therefore suggested the need to rely less on exports to these economies for their growth. This variation in responses to the adverse effects of the Great Recession and the euro-zone crisis, respectively, may reflect uncertainty and considerations of how best to deal with the challenge of managing a change in emphasis from a growth strategy based on exports towards one based more on domestic demand. This challenge should not be underestimated.

There are many difficulties associated with such a shift in growth strategy. For this shift to be sustainable in developing and transition economies that export mainly manufactures, there will need to be both sustained improvements in technological

E. Policy implications

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 71

Chart 2.7

TyPE OF ExPENDITURE AS A ShARE OF GDP, SELECTED ECONOMIES, 2000–2011(Per cent)

Source: UnctadStat.Note: The shares are based on data measured at current prices in dollars.

Household consumption expenditureGross fixed capital formation

Government final consumption expenditure (right scale)Net exports (right scale)

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dynamismandrisinghouseholdconsumptionexpendi-turebasedongrowthofrealdisposableincomethroughnominal incomegrowth, rather than cheap imports.Andthesetwogoalswouldhavetobeachievedsimul-taneously,because,ifdomesticproductivecapacityisnotupgraded,anyriseindomesticpurchasingpowerthroughhigherearningsandtheconsequentincreasein domestic consumption expenditurewould onlyinduceanincreaseinimports.Theresultingimportboomwouldaddtothechangesinthetradebalanceresultingfromstagnatingexportstodevelopedecono-mies.Suchmultiplepressuresonacountry’sexternalaccountswould risk causingbalance-of-paymentsproblemsandstallincomegrowth.inthatcontext,an expansion of themarkets of other developingcountrieswouldbe of paramount importance, notonlybecauseitwouldavoidoralleviatetradebal-ancestrains,butalsobecauseitwouldprovidelargerandmoredynamicdemand,andthereforeencourageinvestmentandtechnologicalupgrading.

individuals require real income growth toengage in higher consumption expenditure.Thiscanresultfromadeclineinpricesofgoods,suchasthroughrisingimportsofgoodsthatarecheaperthandomestically producedones,madepossible by anappreciationoftheexchangerateand/oraprogressivedelinkingofthesectoralstructureofdomesticpro-ductionfromthatofdomesticdemand.However,anyattempttoachieverealincomegrowthbyincreasingimportsofcheapgoodsmaycauseimportstogrowfasterthanexportsandcontributetoagrowingtradedeficit.Thus,policiesaimedatenhancingdomesticdemandneedtobeaccompaniedbyanappropriateexchange-ratepolicytoensureexternalbalance,andbyastrategyaimedat increasingdomesticsupplycapacities.

Theremainderofthissectionfocusesonpoliciesaimedatfosteringbothdomesticpurchasingpowerthroughincomegrowthandtechnologicalupgradingtoboostdomesticproductivecapacity.

1. Policies to boost domestic demand

Since the 1980s, developing countries haveplacedagrowingemphasisonexport-orientedpro-ductiontodriveexpansionoftheirformalmodernsectors.butwhilethisstrategyhasbeensuccessful

insomecountries,inmostcasesdomesticdemandhas not increased at the samepace.This is partlyduetoweaklinkagesbetweentheexportsectorandtherestoftheeconomy,andpartlytothestrategyofdomesticcompaniesandgovernmentstoexploittheirperceived comparative advantage of cheap labourbykeepingwages lowinorder tostrengthen theirinternational competitiveness.but sooner or latersuchastrategywillreachitslimitsduetothecon-straintimposedbylowwagesondomesticdemandgrowth, especiallywhen global demandweakensandmanyothercountriespursuethesamestrategysimultaneously.

Therefore,policiestoboostdomesticdemandasanengineofgrowtharewarranted,notonlybecauseofthecurrentdeflationarytrendintheworldecono-my,butalsobecauseastrategyofexport-ledgrowthbasedonwagecompression,whichmakescountriesoverlydependentonforeigndemandgrowth,maynotbesustainableforalargenumberofcountriesandoveralongperiodoftime.

Agrowthstrategythatgivesgreateremphasisto domestic demand growthmust start from therecognition that, even in relatively poor countriesandincountrieswitharelativelylargeexportsec-tor,labourincomeisthemajorsourceofdomesticdemand.Therefore,policiesaimedatincreasingthepurchasingpowerofthepopulationoverall,andwageearnersinparticular,needtobethemainingredientofastrategythatfavourspromotingdomesticrela-tivetoexternalsourcesofgrowth.inmanycountries,thetwoothermaincomponentsofdomesticdemand–privateinvestmentandpublicsectorexpenditure–mayalsohelptoadvancesuchastrategy.

inanycase,thereisastronginterdependencebetweenthethreecomponentsofdomesticdemand.First,increasedconsumptionofgoodsandservicesthatcanbeproduceddomesticallymakesproducersofthesegoodsandservicesmorewillingtoinvestintheirproductivecapacity.Second,higherinvest-mentwillcreateadditionalemploymentandwageincome,andthusincreaseboththepurchasingpowerofdomesticconsumersandthetaxrevenuethatcanbespentbythegovernment.Moreover,productivitygainsresultingfromadditionalinvestmentallowafurtherincreaseinwagesandconsumption.

Third,higherpublicspendingcanhaveapositiveimpactonbothprivateconsumptionandinvestment

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 73

throughvarious channels. it can create additionalincomeforconsumersandimprovetheconditionsforprivateinvestment.Thelatter isnotonlyitselfasourceofdomesticdemand(evenifalargeshareofthecapitalgoodsmayhavetobeimported),butisalsoindispensableforexpandingdomesticsupplycapacity,andconsequentlyforreducingleakagesofdomestic demandgrowth through imports. Publicinvestmentininfrastructureisoftencomplementaryto,ifnotaprerequisitefor,privateinvestment,andhelpstoincreaseoverallproductivityintheeconomy.Totheextentthatthepatternofpublicrevenueandpublic spending contribute to reducing incomeinequality,consumptionwillbehigheratanygivenleveloftotalincome,becauselowerincomeearnersspendalargerproportionoftheirincomethanhigherincomeearners,andtheshareofdomesticallypro-ducedgoodsandservicesintheirconsumptiontendstobegreaterbecausetheyarelesslikelytoconsumeimportedluxurygoods.Finally,ifthepublicsector’scontributiontoGDPislarger,governmentshavemorepossibilitytocompensateforfluctuationsindomesticandexternaldemandthroughcountercyclicalfiscalpolicies,andthuspreventlargeswingsinconsump-tionandinvestment.

(a) Increasing domestic consumption

Policiesthatresultinadeclineofthewagesharehaveoftenbeenjustifiedasbeingnecessarytoreduceproductioncostsandinduceinvestment.However,asnotedabove,householdconsumptionconstitutesthelargestshareofeffectivedemandinmostcountries,developedanddevelopingalike.

indeed, empirical evidence suggests thatchangesinthewagesharearepositivelycorrelatedwithchangesintheshareofhouseholdconsumptioninGDP(asreflectedinthefiguresonthelefthandsideofchart2.8).Giventhatmostcountriesshowadeclineinthewageshare,thispositivecorrelationimpliesa decline in the share of household consumptioninGDP.22bycontrast,thereisnoclearcorrelationbetweenchangesinthewageshareandtheshareofinvestmentinGDP(figuresontherighthandsideofchart2.8).ThelattercorrelationismildlypositiveinAfricaandnilindevelopedeconomies.bycontrast,itisnegativeineast,SouthandSouth-eastAsiaandinlatinAmerica,thoughsmallerinabsolutetermsthanthecorrelationbetweenchangesinwagesharesandthoseinconsumption.23

ofcourse,thesecorrelationsneedtobeinter-pretedwithcaution,andshouldnotbeconsideredasindicativeofcausality.inparticular,theyshouldnotbeinterpretedasshowingthatinAsiaandlatinAmerica,higher investment ratesdependonwagecompression. inmostSouth-eastAsian countries,investment rates fell significantly after theAsiancrisisof1997–1998,evenincountrieswherewagesandconsumptionalsofellasashareofGDP,andwerebalanced by a commensurate improvement in thecurrentaccountbalance.RegardinglatinAmerica,thecomparisonbetweentwopointsintimemaybemisleading,because2002–2003markedachangeinthetrendsofbothincomedistributionandinvestmentrates. in several countries (e.g.Argentina and thebolivarianRepublicofVenezuela), sharesofbothinvestmentandlabourinGDPdeclinedbetweentheearly1990sand2002,andthenrecoveredintandeminthesubsequentyears,showingapositivecorrela-tionthatisnotapparentinthechart.Finally,thecaseofChinaillustratesthataslongasadecliningwageshareisaccompaniedbyrapidincomegrowth,itdoesnotimplyanabsolutefallinlivingstandards.

Soon after the onset of the current financialcrisis,GDP growth in developing and transitioneconomies remained relatively high or recoveredquickly, as the deceleration or even a decline oftheirexportswascompensatedforbyfastergrowthof domestic demand resulting from expansionarymonetaryandfiscalpoliciesandfasterwagegrowth.The rapid recoveryof some large developing andtransition economies also provided amarket forsmaller countries that cannot rely solely on theirdomesticdemand.

in order to sustain these domestic demanddynamicsstemming fromcountercyclicalpolicies,and in somecasesalso from terms-of-tradegains,growth-supportingmonetaryandfiscalpolicieshavetobecomemorepermanentfeatures,astheywereinthe developed countries during “theGoldenAge”andinthoseemergingeconomiesthatwerethemostsuccessfulincatchingupduringthe1980sand1990s.butinorderforgovernmentsandcentralbankstopursuefiscalandmonetarypolicies,includingsup-portivepublicinvestmentandlowinterestratesthatremainfavourabletoprivatedomesticcapitalforma-tionoverlongperiodsoftime,itisalsonecessarytokeep inflation incheck.Achievingbothobjectives–rapiddomesticdemandgrowthandrelativepricestability–couldbegreatlyfacilitatedifthetraditional

Trade and Development Report, 201374

Chart 2.8

ChANGES IN wAGE ShARES, PRIVATE CONSUMPTION AND PRIVATE INVESTMENT IN SELECTED GROUPS OF COUNTRIES FROM 1991–1994 TO 2004–2007

Source: UNCTAD secretariat calculations, based on UN-DESA, National Accounts Main Aggregates database; ILO, Global Wage database; and OECD.StatExtracts database.

Note: Data refer to changes in percentage points of the average GDP for each period. When no observation for wage share was available for the period 1991–1994, the first subsequent observation was used. For Brazil, Mongolia and Niger, data refer to 1995; for Cameroon, Chile, Egypt and Kenya, data refer to 1996; for Panama, data refer to 1997; for Sri Lanka and Uruguay, data refer to 1998; for India, Indonesia, Mongolia and Peru, data refer to 1999; for Pakistan, data refer to 2000. The shaded area represents the 95 per cent confidence interval.

Austria

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SwitzerlandGermany

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Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 75

macroeconomicpolicytoolkitwerecomplementedbyanappropriateincomespolicy.

Acentralfeatureofanyincomespolicyshouldbetoensurethataveragerealwagesgrowat leastat a similar rate as averageproductivity.PreviousTDRshaverepeatedlydrawnattentiontothemeritsofestablishingsuchalinkwithaviewtocreatingemploymentandavoidingafurtherdeteriorationofincomedistribution (TDR 2010, chap.V andTDR 2012, chap.Vi).These considerations are equallyrelevant for domestic-demand-led growth strate-gies,becausewagegrowthinlinewithproductivitygrowthshouldbeabletocreateasufficientamountofdomesticdemandtofullyemploygrowingpro-ductive capacitiesof the economywithouthavingto rely on continued export growth.At the sametime,inflationcanbekeptwithinalowrangewhennominalwagesarenotadjustedtopreviousratesofinflation,whichwouldriskcausinginflationinertia.Rather,nominalwageadjustmentsshouldtakeintoaccountaninflationtargetthatguidesthemonetarypolicyoftherespectivecountry(seealsoTDR 2012,chap.Vi).Thiswouldgreatlyfacilitatethetaskofthecentralbanktopreventinflation,andwidenitsscopetostimulateinvestmentandgrowth,asproposedinchapteriiiofthisReport.

Theeffectivenessofsuchanincomespolicythatensuresasustainedexpansionofdomesticdemandaswell as low inflation could be enhanced by astrengtheningofcollectivebargainingmechanisms(or their introductionwhere theydonotyetexist)andbyminimumwagelegislation.Collectivebar-gainingofwages,andemploymentconditionsmoregenerally,wouldalsohelptoachievegreatersocialconsensus about incomedistribution and enhancesocial cohesion, provided that bothworkers’ andemployers’ associations, andpossibly governmentrecommendations or guidelines for such negotia-tions,broadlyadhere to thewageadjustmentrule.Suchmechanismsmaybedifficulttoimplementinmanydevelopingcountrieswhere the institutionalframeworkforstructurednegotiationsfordetermin-ingwages and employment conditions remains tobecreated.

The introduction of a legalminimumwagemay therefore serve as a useful instrument toprotect theweaker social groups, but also, if it isregularly adjusted to average productivity growthintheeconomy,asameanstoexpanddemandfor

mostly domestically producedgoods and services(TDR 2012,chap.Vi.D).Minimumwagesmaypushup the prices of some labour-intensive goods andservices,butthepurchasingpowerofalargegroupofemployeeswouldalsorise,thushelpingtocreateadditionalincomeandemploymentthroughouttheeconomy(seealsoG20,2012:12).Moreover,regularadjustmentofthelegalminimumwagecanprovideanimportantreferenceforwagenegotiationsintheprivatesector.

legalminimumwages already exist inmostofthedevelopedcountriesandinmanydevelopingcountries,butincountrieswherethereisalargepro-portionofinformalandself-employment,itisoftendifficult to enforce such legislation.Therefore, inthesecountriesitisimportanttocomplementpoliciesaimedatincreasingformalemploymentandincreas-ingthepurchasingpowerofemployeesintheformalsectorwithmeasurestoboostincomesandthepur-chasingpoweroftheinformallyandself-employed.

inthiscontext,anumberofdevelopingcountrieshaveintroducedpublicsectoremploymentschemesin order to reduce widespread unemploymentandpoverty (TDR 2010, chap.V; and TDR 2012,chap.Vi).Suchschemescanplayanimportantrolewithinastrategytoraisedomesticdemand.incoun-trieswherealargereserveofsurpluslabourexists,andwherecompetitionbetweentheemployedandtheunemployedandunderemployedtendstodrivedownearnings,publicsectoremploymentnotonlyhasadirectdemand-generatingeffect;thetermsofsuch employment, especially the remuneration ofworkers,canalsohelptoestablishafloortothelevelofearningsinboththeformalandinformalsectors.Similartowagesintheprivatesectorandminimumwage levels, remuneration of such employmentshould also be improved over time at a rate thatappropriatelyreflectstheaveragegrowthofproduc-tivityintheentireeconomyaswellastheincreaseintaxrevenuesinagrowingeconomy.Thelayersofthepopulationthatbenefitdirectlyorindirectlyfromtheintroductionofsuchschemesarelikelytospendmostoftheirincomes,andmorethantheaverage,onlocallyproducedgoodsandservices.

incountrieswitha largeruralsector thathasmanysmallproducers,mechanismsthatlinkagricul-turalproducerpricestooverallproductivitygrowthintheeconomywouldbeanotherelementofastrat-egytoincreasedomesticconsumption.Atthesame

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time,itwouldraiseproductivity,ashigherincomeswouldenableproducerstomakegreaterinvestmentsinequipment.Suchmechanismshavebeenappliedsuccessfullyinalldevelopedcountriesfordecades.

Consumers’ disposable income can also beinfluencedbygovernmentprovisionofbasicservices(financed, for example, though increased taxationofhigherincomegroups),suchashealthcare,careforchildrenandtheelderly,educationandhousing,whichwilltendtoreducetheprecautionarysavingsofthelowerandmiddle-incomegroups.itcanalsobe influencedbychanges in tax ratesand transferpaymentswithaviewtoreducingincomeinequal-ityandboostingthepurchasingpoweroflow-andmiddle-incomehouseholds.

inaddition,governmentscantakediscretionaryfiscalactions,includingpromotingtheconsumptionof durable consumer goods, for example throughtargetedfiscaltransferssuchastaxrebatesoncertainconsumergoods.24incountrieswithadomesticcarindustry,passengercarshaveoftenbeensuchatar-get,includingaspartofcountercyclicalmeasures.Awiderangeofdevelopedcountries,aswellassomedevelopingcountries (e.g.China)spurrednewcarsalesthroughso-called“cash-for-clunkers”schemesin2008–2009.Giventhatsuchschemesgenerallyaimatreplacingoldcars,whicharemorepollutingandlessenergyefficient,withnewones,theseschemesalso help to achieve environmental targets. Someotherdevelopingcountrieshavesuccessfullyadoptedsimilarschemestargeting“first-carpurchases”.25Forexample, in2011Thailandadopted a scheme thatallowedfirst-timecarbuyerstoapplyforataxrefundoncarsmanufacturedinThailand.26

Householdconsumptionexpenditurecanalsobespurredbyfacilitatingaccesstoconsumercreditfortheacquisitionofdurableconsumergoods.27Aneasingofconsumercreditmayresultfromchangesincreditconditionsorfromwealtheffectsbasedonincreasedassetpricesthatmakeiteasierforcertainmiddle-class consumers to provide collateral forloans.However,thereareconsiderablerisksinvolvedinencouraginganincreaseofhouseholdconsumptionbasedonconsumercredit, as amplydemonstratedby recent experiences in a number of developedcountries,where episodes of fast growth of suchcreditwereattheoriginof,oratleastcontributedto,balancesheetdisequilibriathatendedinsubstantialfinancialturmoil.intheUnitedStateshouseholddebt

asashareofGDPincreasedrapidlyduringthedecadepriortotheonsetoftheGreatRecession,reachingapeakof102percentin2007(chart2.9).Thisincreasewascloselylinkedtorisinghouseprices,combinedwiththefactthatalmosttwothirdsofhouseholddebtstemmedfrommortgages.Thisalsoresultedinanincreaseinhouseholddebtasashareofhouseholdconsumptionexpenditure,whichpeakedat145percentin2007.

inmostdevelopedcountries,householdshavestronglyreduceddebtbypayingitoff,oroftentheyhave defaulted,with attendant adverse effects onhousehold consumption expenditure.by contrast,thereseemstobeanunabatedtrendtowardsincreasedhouseholdleveragingindevelopingcountries.Thismaybetheresultofacombinationofthreefactors:a quick economic recovery from the downturn in2008,which contained job losses, sustained lowinterestrates,andassetpriceinflation,includinginrealestate.28

Amongdevelopingandtransitioneconomies,the level of household debt as a share ofGDPhas becomeparticularly high inMalaysia and theRepublic ofKorea,where it exceeds 80 per cent(chart2.10).boththesecountrieshavealsoseenasig-nificantriseinhouseprices.AtleastintheRepublicofKorea,thegrowthofhouseholddebtandhousepricesmaybecloselylinked,as“mortgagesandotherhousingloansmakeupalmost53percentofhouse-holddebt”(McKinseyGlobalinstitute,2013:25).Householddebt inMalaysiahas increasedsharplysince2008,itsratiotodisposablepersonalincomerisingfrom150percenttoalmost190percent.inbrazil,China, indonesia andThailand, there hasalsobeenastrongincreaseinthisratiosince2008,thoughatconsiderablylowerlevels(chart2.10).Sucharapidgrowthofhouseholddebtcanrapidlyplaceaheavyburdenonhouseholdbudgetsandconsider-ably reduce their consumptionexpenditure.brazilforexample,witnessedasharp increase indefaultrates on consumer loans in 2011,making banksincreasinglyreluctanttolend,eventhoughadeclineofbenchmarkinterestratestorecordlowssincethenhashelpedstemdefaultrates.29

itisdifficulttoassesswhatlevelsandgrowthrates of householddebt are sustainable.However,thereareindicationsthatlargerandpersistentcreditgrowth,aswellasgrowthepisodesthatstartatrela-tivelyhighdebt-to-GDPratios,poseagreaterrisk

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 77

ofacreditbust,withensuingadverseeffectsonthestabilityofacountry’sfinancialsystem(Dell’Aricciaetal.,2012).itisalsodifficulttoassesstheextenttowhichrapidlyrisingand/orelevateddebtlevelstranslateintoexcessivedebtservicingburdensanddecliningconsumptionexpenditure.ifanythresholdsexistinthisarea,theywillbedeterminedbyawiderangeoffactors,includingtheincomestructureofdebtorsandthematurityandinterest-ratestructureofloans.Relatedcomprehensivedataarenotavail-ablefordevelopingcountries.Macro-levelmonetarypolicyeasingcan smooth theburdenof the risingcostofhouseholddebtservicing.butforthesamereasonitcanalsoinducefurtherborrowing,unlesssuchmacroeconomic policy easing is combinedwithmicro-levelmeasures such as tighter regula-tions relating to loan-to-value anddebt-to-incomeceilings.30

Thereisthepossibilityofaloomingfinancialcrisisinthosecountrieswherethegrowthofhouse-hold debt steadily exceeds incomegrowth and/orwherethesizeofoutstandinghouseholddebtcon-siderably exceeds the size ofGDP.A crisis couldbe triggered by a perception that asset prices are

overvalued,withanassociatedcollapseofhouseholdwealth.butthetriggercouldalsobeasuddensize-able increase in interest ratesora renewedglobaleconomicdownturn thatwould causedeveloping-country exports to decline and domestic incomestofall.Thiswouldmakeitincreasinglydifficultforhouseholdstoservicetheirdebt,resultinginturmoilinthefinancialsectorofthecountryconcerned.

Tosumup,apolicyaimedatspurringhouseholdconsumptionexpenditurebyeasingtheconstraintsonborrowingtendstoberisky.Unlesssuchastrategysuccessfullyjump-startsavirtuousprocessofaccel-erating domestic demand and supply, itmaywellcausesubstantialfinancialandeconomicturmoil.Thedebtservicingburdenmayrapidlybecomeexcessiveif interestratesrise,growthofhouseholdincomesstallsorpropertypricesfall.Anysuchdevelopmentwould eventually restrain household consumptionexpenditure.Amoresustainablestrategywouldthusbetheimplementationofanincomespolicysuchasoutlinedabove.butthecreationofincomeopportu-nitiesandproductivitygrowththatenablessustainedincreases in realwages is closely associatedwithfixedcapitalformation.Thelatterhasbeenadriving

Chart 2.9

hOUSEhOLD DEbT AND hOUSE PRICES IN ThE UNITED STATES, 1995–2012

Source: UNCTAD secretariat calculations, based on Bank for International Settlements (BIS), Credit to Private Non-Financial Sectors database; the Federal Reserve, Flow of Funds Accounts of the United States; and the Federal Reserve Bank of Dallas, International House Price Database.

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Chart 2.10

hOUSEhOLD DEbT AND hOUSE PRICES, SELECTED DEVELOPING COUNTRIES, 2000–2012

Source: UNCTAD secretariat calculations, based on data from the United Nations Statistics Division; Bank for International Settlements, Credit to Private Non-Financial Sectors database; and Federal Reserve Bank of Dallas, International House Price Database.

Note: House price data for Brazil were not available.

Nominal house prices (right scale)

Household debt as a share of disposable personal incomeHousehold debt as a share of household consumption expenditureHousehold debt as a share of GDP

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Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 79

forcefordevelopmentinthosedevelopingcountriesandemergingmarketeconomiesthathavebeenthemostsuccessfulintheireffortstocatchupwiththedevelopedeconomies.bycontrast,ithasremainedat relatively low levels inmanyother developingcountries,especiallyinAfricaandlatinAmerica.

(b) Promoting domestic investment

Akeydeterminantofthewillingnessofentre-preneurstoinvestinrealproductivecapacityistheexpected profitability of a potential investment,whichinturndependsonestimatesthathelpdeter-minewhetherfuturedemandwillbehighenoughtofullyutilizetheadditionalproductivecapacity.

Whenwagesgrowataslowerratethanprod-uctivity, theadditionalsupplycanonlybeutilizedprofitablywhenthereisacontinuedincreaseinexportdemand. in the absence of such demand growth,productivecapacitywillbeunderutilized,and thiswill discourage further productive investment andinnovation.Given the current conditions of theworldeconomy,exportsareunlikelytogrowatthesamepaceasinthepast,thuswage-drivendomesticdemandgrowthwillbecomeamoreimportantfactorinthedemandexpectationsofpotentialinvestors.butafavourableenvironmentfordomesticinvestmentalso requires supportivefiscal policies (discussedin the next subsection) andmonetary conditions,includingacompetitiveexchangerate,andfinancialpoliciesaimedatallowingpotentialinvestorsaccesstolow-costcredit.

Amonetary policy that seeks to strengthendomesticdemandandsupplycapacitieswouldkeepthelevelofinterestrateslow.inthepast,attemptstouseonlymonetarypolicytofightinflationoftenledtohighrealinterestrates,whichdiscouragedprivatedomestic investment for two reasons. First, theymeanthighfinancingcostsforpotentialinvestors,andsecond,theyoftenattractedforeigncapitalinflowsofaspeculativenature,whichtendedtoresultincur-rencyovervaluationandalossofcompetitiveness.Thisreducedtheexportopportunitiesanddemandexpectations of domestic producers.An incomespolicy based on a regime of productivity-alignedwagegrowth,asoutlinedabove,wouldfacilitatethepursuitofamonetarypolicy that fostersdomesticinvestment,becauseitwouldalsoexclude,oratleastsignificantlyreduce,theriskofinflationasaresultof

risingunitlabourcosts.Moreover,whenexchangeratemanagementandcapitalaccountmanagementcan ensure a stable real exchange rate, they canpreventunnecessaryleakagesofdomesticdemandtoforeignmarketsduetothereducedinternationalcompetitivenessofdomesticproducers.

Financial policies should facilitate access tocreditforsectorsandactivitiesthatareofstrategicimportanceforthestructuraltransformationoftheeconomy.Suchfinancial support,whichhasoftenbeenusedas an instrumentof industrialpolicy indeveloped countries and in successful emergingeconomiesinAsia,couldalsohelpsolvetheproblemofaccesstoadequatefinancingfacedbymanysmall,ofteninnovativefirms,includingthoseintheinformalsectorandinagriculture,whichproduceprimarilyfor the domesticmarket. examples of such poli-ciesincludethedirectprovisionofcreditbypublicfinancialinstitutionsorbyinterventioninfinancialmarketsthroughsuchmeasuresasinterestsubsidies,refinancing of commercial loans andprovision ofguaranteesforcertaintypesofcredit.

Suchmeasures are of particular importancewhere the formalmanufacturing sector is stillrelativelysmall. in thatcase, it isnotonlycapitalformation in the formalmanufacturing sector thatcancontributetohigherdomesticdemandandgreaterdomestic supply capacity, but also productivity-enhancinginvestmentintheagriculturalsectorandin small businesses. Small-scale farmers and theself-employedpursuingnon-farmactivitiesinbothruralandurbanareasareparticularlydependentonfinancialsupportschemes,becauseitisoftendifficultorimpossibleforthemtomakeevensmallinvest-mentsowingtoproblemsorlackofaccesstolow-costfinancefromcommercialbanks(McKinley,2009).

Productivityintheagriculturalsectorcanalsobeenhancedthroughpublicinvestmentinagricul-turalresearchandruralinfrastructureandpubliclyassisted agricultural support organizations.Manysuch organizations were dismantled during thestructural adjustment programmes of the 1990s,partlyinthecontextofsweepingliberalizationandprivatization,andpartlybecauseanumberofthemhadseriousgovernanceproblems.butifsuchorgani-zations are equippedwith appropriate governancestructures, theymay be instrumental in fosteringincomegrowthinruralareasbyprovidingessentialextensionservices,disseminatinginformationabout

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productivity-enhancing investments and efficientmarketing,andfacilitatingaccessofsmallfarmerstoaffordablecredit.ensuringtheparticipationoftheagriculturalsectorinoverallproductivitygrowthandthegenerationofhigherpurchasingpowerofthoseworking in thissectormayalsorequireprotectingfarmers against the impact of competition fromhighly subsidized agricultural products importedfromdevelopedcountries.

2. The role of the public sector in strengthening domestic demand

(a) Direct and indirect demand effects of public expenditure

overmanyyears,economicpolicywasorientedtowardsarelianceonmarketforcesaskeydriversofgrowthanddevelopment,withareducedsizeofthepublicsectorintheeconomy.Governmentinterven-tionwasconsideredineffectiveonthegroundsthatanincreaseinpublicexpenditurewouldcauseareduc-tion in private expenditure.This, itwas assumed,wouldresultingreaterdistortionsinresourcealloca-tionthanthosegeneratedbythemarketmechanismalone, leading to suboptimal outcomes for theeconomyasawhole.itiscertainlytruethatthepublicsectorhasasignificantdirectandindirectinfluenceonfactorallocation,butthe“distortions”thiscreatesare not necessarily negative for the economy andsocietyaswhole.Moreover,whilepublicfinancesinfluencefactorallocationatagivenlevelofincome,totheextentthattheystrengthenaggregatedemandtheyraisethelevelofnationalincome.Taxationandpublicspendingarepotentiallykeyinstrumentsforshapingthedistributionofpurchasingpowerintheeconomyandforestablishinglinkagesbetweencom-paniesinthemodernsectors,exportindustriesandtherestoftheeconomy,whichthemarketmechanismoftenfailstoaccomplish.

Publicinvestmentinvitalinfrastructuretoensuretransport,water and electricity supply or servicestospecific industrialclusters isoftenaprerequisiteforprivate investment tobecomeviable.Similarly,public expenditure on education and training caninfluence the quality and skills structure of thelabourforceandthepotentialoflabourtocontributetoproductivitygrowth.Thisinturnleadstohigher

wagesandastrengtheningofdomesticdemand.inmostdevelopingcountries there isalsoapressingneedtoincreasepublicsectorprovisionofessentialsocial services, especially those concernedwithnutrition,sanitation,healthandeducation.

Moreover,governmentscanprovidefiscalincen-tivesintheformoftargetedtaxrebatesandtemporarysubsidies, aswell as improved public services toexistingfirmsandpotentialentrepreneurs.Successfuldevelopment experienceshave shown that if suchmeasures are conceived as elements of a compre-hensive industrial policy, they can accelerate thediversificationofeconomicactivitiesandthedevelop-mentofstrategicsectorsintheeconomy.Atthesametime,theycancontributetoemploymentcreation,andhencetoanexpansionofdomesticdemand.

byinfluencingincomedistribution,thestruc-tureoftaxationhasindirecteffectsondemand,sinceit has an impact on the pattern of net disposableincomes across different social groups.Aggregateconsumptionandtheincentiveforprivatefirmstoundertakefixedinvestmentsisgreaterwhenagivennationalincomeisdistributedmoreequally,becauselower incomegroupsspenda largershareof theirincomeonconsumption,ingeneral,andondomesti-callyproducedgoodsandservices,inparticular,thanhigherincomegroups.Tax-financedsocialtransferscanhavesimilareffectsondomesticdemand.

Moreover, countercyclical fiscal policy canstabilizedomesticdemandduringperiodsof slowgrowthorrecession,andthusthedemandexpecta-tionsofdomesticinvestors.ThelargertheshareofthepublicsectorinGDP,thegreaterwillbethepotentialforstabilization.

(b) Raising public revenues

Higherpublicspendingforpurposesofstrength-eningdomesticdemandrequiresanincreaseinpublicrevenuesfromtaxesorothersources.Alternatively,itmayberationaltofinancecertaintypesofpublicexpenditurebyborrowing.Yetitisoftenarguedthatthefiscalspaceavailabletogovernmentsindevelop-ingcountriesistoolimitedtoextendpublicsectorspending.

Clearly, fiscal space in developing countries,especiallyinlow-incomeandleastdevelopedcountries

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 81

(lDCs) is smaller than in developed and emerg-ingeconomiesowingtotheirlowlevelofnationalincome.Moreover, in developing countries, fiscalspace isoften strongly influencedby internationalfactorsthatarebeyondthecontrolofthesecountries’governments, such as fluctuations of commod-ity prices, of interest rates on the public externaldebt,andofexternalfinancingintheformofeitherprivate capital inflowsoroDA.However,withintheseconstraints,fiscalspaceislargelydeterminedendogenously; a proactivefiscal policy influencesthemacroeconomicsituationandtheoveralltaxbasethroughitsimpactonprivatesectorearnings.

Taxesplaceaburdenonthedisposableincomeoftheindividualtaxpayer.Consequently,itisfrequentlyassumed that taxes divert income and purchasingpower away from the private sector.but this is astaticviewthatneglectsthefactthattheperceivedtax revenuewill flow back to the private sectorand increase aggregate income in the economy,therebyenlargingthetaxbase.itisoftenforgottenthatthenetdemandeffectofaparallelincreaseintheaveragetaxrateandgovernmentexpenditureispositive,sincesomeoftheadditionaltaxpaymentsareattheexpenseofthesavingsoftaxpayers,whilespending of the tax revenuewill cause aggregatedemandtorisebythefullamountofthetaxyield(Haavelmo,1945).Thisneteffectofadditionaltax-financedexpendituretendstobegreaterifmoreoftheadditionaltaxburdenfallsonthehigherincomegroups(who,ofcourse,willalsoseetheirincomesincrease, as theyparticipate in theoverall incomeeffectoftheadditionalexpenditure),andifthelargershareofpublicexpenditureisspentondomesticallyproducedgoodsandservices.Thescopeforusingtaxationandgovernmentspendingforstrengtheningdomesticdriversofgrowthmaythereforebegreaterthaniscommonlyassumed.

ofcourse,iftaxratesareraisedaboveacertainthreshold, the behavioural response of thosewhohavetobearthelargestshareofthetaxburdenmaycausethetaxbasetoshrinkalongwiththeeconomicactivity that determines the tax base.However, itisdifficult todetermineanupper limit for the taxburden,which not only depends on the level oftaxrates,butalsoonhowthetaxrevenueisused.Regarding the income tax rate, it has been foundthatindevelopedcountries,thetopmarginalrateatwhichthetotaltaxyieldwillbemaximizediscloseto60percent(Piketty,SaezandStantcheva,2011),

andthere is littlereasontobelieve that it ismuchlowerindevelopingcountries,whereincomesoftengrow faster than in developed countries.Taxinghigh incomesathigher ratesbyusingprogressivescales does not remove the absolute advantageofricherindividuals,andneitherdoesittakeawaytheincentive for entrepreneurs to innovate andmoveuptheincomeladder.Regardingthecorporatetaxrate,itiscertainlytruethatfiscalmeasurestofosterprivatefixedinvestmentareessential,butthisdoesnotmeanthattaxationofprofitsmustbekepttoaminimum;reductionsofcorporateincometaxrateshaverarelymotivatedadditionalinvestmentsinfixedcapital(TDR 2012,chap.V;Devereux,GriffithandKlemm,2002).

Giventhelowdegreeofprogressivityindevel-oping and transition economies’ tax systems andthelargedifferencesbetweenregionsandcountriesin this regard, theremay still be scope formoreprogressive taxation inmany of these countries.levyinghighertaxesonthemodernsectorandonhighlyprofitable export activities enables govern-mentstoprovidefinancialsupportforproductivitygrowthandincomegenerationinthetraditionalandinformal sectors.of course, this requires suitableadministrativecapacity.inthisregard,theconditionsindevelopingcountriesvarygreatly,dependingontheirlevelofdevelopment,thesizeoftheirinformalsectorandthecompositionoftheirGDP.ontheotherhand,thereareanumberofotherpotentialsourcesof revenue that are also available in low-incomecountries.Taxationofwealthandinheritanceisonesuchsourcethatcouldbetappedinmanydevelopingcountries.itrequiresrelativelylittleadministrativecapacityandishardertocircumventthanmanyothertaxes.inmanyresource-richcountriestheremaybeconsiderablescopeforcollectingalargeramountofroyaltiesandtaxesfromcompaniesactiveintheoil,gasandminingsectors.Thisisparticularlyimportantbecausetherevenuepotentialfromnaturalresourceshasgrownsignificantlyoverthepastdecade,espe-ciallyinAfrica,andadisproportionallylargeshareoftherentsfromtheextractiveindustriesarecapturedbytransnationalcorporations(TNCs).

inthemanufacturingsectoraswell,itmaybepossibletoraiseadditionalrevenuethroughamorerationaltaxtreatmentofTNCs.Considerableforeigndirect investment (FDi) is attracted to developingcountriesbecauseitallowsTNCstocombinethelow-costlabourofthehostcountrywithmoreadvanced

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technology andmore capital-intensive productiontechniques than are locally available, resulting inunit profits that aremany times higher than theycould realize in their homecountry.Alternatively,TNCscansubstantiallyreducethesalespriceoftheirproductsandtherebygainmarketshares.Thus,thebenefitsofFDiintermsofproductivitygainswillbecapturedeitherbytheforeigninvestorintheformofhigherprofits,orbyforeignconsumersintheformof lowerpurchasingprices.Meanwhile,very littleofthose,oftenenormous,productivitygainsbenefitthehosteconomies.

insomecountriesthatpursueacoherentindus-trialpolicy,themarketmechanismmayleadforeigncompaniestopurchaseintermediateinputsfortheirproductionfromthelocalmarket.Thisshouldgener-atesomedemandandemploymentintheeconomyofthehostcountry.However,inmanyinstances,themarketmechanismmaynotgeneratesuchlinkages,inwhichcaselocalcontentrequirementsininvestmentagreementsmighthelp,providedthatthenecessarylocalsupplycapacitiesexist.ifthisisnotthecase,orinadditiontothoserequirements,adequatetaxationofhighprofitsresultingfromthelowlabourcosts–whichattractedtheTNCsinthefirstplace–couldbeinstrumentalinensuringthatlinkagesarecreatedwiththerestoftheeconomy.Thoselinkagescouldleadtothecreationofdomesticdemand.

TNCs can also contribute to strengtheningdomesticdemandinthehostcountriesbyofferingwagestotheirlocalemployeesthataremoreinlinewiththeirproductivitygains.Moreover,governmentsinthesecountriesmaybewelladvisedtore-evaluatethebenefitsofforeigninvestmenttodomesticincomegrowth:notonlylowwages,butalsofiscalarrange-mentstoattractFDimaybedeprivingtheStateofcruciallyneededpublicrevenuetofinancedevelop-mentprojectsthatareaprerequisiteforpromotinga domesticmanufacturing sector.Many countriescompetewith other countries in offering lowertaxestoTNCstoattracttheirproductionfacilities,similar towage competition, often resulting in aracetothebottom.Suchpoliciesareattheexpenseofallthecountriesthatenterintosuchtaxandwagecompetition.

inorder to stopadownward spiralofwagesandtaxationfromthisprocess,internationalarrange-mentsmayproveindispensable.ThesemayincludeaninternationalcodeofconductforTNCs,governing

theemploymentconditionstheyoffertoworkersindevelopingcountries,andstrengthenedinternationalcooperationintaxmatters.Suchcooperationshouldaim at reducing tax evasion, aswith theUnitedNationsModelDoubleTaxationConventionbetweenDeveloped andDeveloping Countries. equallyimportant,thereshouldbeabetterbalancebetweenensuringthatgovernmentscompetingforproductionlocations reap a fair share of fiscal benefits fromTNCs’operationsintheircountries,whilepreservingtheadvantagethatforeigninvestorscanderivefromFDionthebasisoflabourcostdifferentials.Takingintoaccountthelargedifferencesinunitlabourcostsbetweenthehomeandhostcountries,thisbalancewould likely allow a higher level of tax revenuesfor the host country,while the level of profits ofthe foreign investors from their production in thehostcountrymaybesomewhatlowerthanbefore,althoughstillseveraltimeshigherthanifitproducedthesamegoodsinitshomecountry.

inseverallow-incomeandleastdevelopedcoun-triesitmaystillbedifficultorimpossibletopromptlyimplementanyofthesemeasurestoincreasefiscalspacebecauseoftheirlimitedadministrativeandtaxcollectingcapacities.inthesecases,themultilateralfinancialinstitutionsandbilateraldonorscouldhelpbyprovidingadditionalresourcesforsocialspend-ing,aswellastheappropriatetechnicalandfinancialsupportforstrengtheningthosecapacities.

(c) Debt-financed public spending

Debtfinancingofpublicexpendituremaybeconsideredanappropriatemeasurefortwostrategicreasons.oneisthecountercyclicaleffectarisingfroman increase in public sector demandwhenprivatedemandisinsufficienttomaintaineconomicactivityatalevelwherethelabourforceandtheexistingcapi-talstockarefullyemployed,particularlywhenthisisaccompaniedbyareductionofnetprivateborrowing,asinthecurrentsituationofbalance-sheetrecessionexperiencedinanumberofdevelopedcountries.Theotheristoacceleratedomesticcapitalformationbycredit-financed public investment in projects thathavealonggestationperiod,suchasinfrastructure,whichwillbeusedforseveralyearsorevendecades.Thesewillbenefitnotonlythecurrentgenerationoftaxpayersbutalsofuturegenerations,whosetaxpay-mentswillthenbeusedtoservicethedebt.

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 83

Thereisawidespreadviewthat,totheextentthatpublicexpenditure isfinancedbygovernmentborrowing,privateagentswilltendtoreducetheirdemandfortworeasons.First,increasedborrowingbythepublicsectorwillpushupinterestrates,whichwillcutprivate investment,andsecond,consumerdemandwillfallandsavingswillrise,becausecon-sumerswillexpecttopayhighertaxessometimeinthefuturetoenablethegovernmenttorepayitsdebt(barro,1974).However,boththesepropositionsareflawed.Thefirstisbasedontheerroneousassumptionthatthepublicandprivatesectorscompetefortheuseofagivenpooloffinancialresources.Accordingtothisview,ifthepublicsectorabsorbsfewerfinancialresources,morewillbeavailablefortheprivatesec-torforproductiveuse(iMF,2003:6and110–111).However,thereislittle,ifany,empiricalevidenceofacrowdingoutofprivateinvestmentbypublicbor-rowing(TDR 2010,box3.1;Aschauer,1989).onthecontrary,publicinvestmenthasbeenfoundtohaveanoverallcrowding-ineffectonprivateinvestment.

evenarelativelylargeincreaseingovernmentborrowing is unlikely to push up interest rates,becausethisincreasewouldstillbemarginalcom-paredwiththetotalamountofassetsinthecapitalmarket.Moreimportantly,theinterestrateisitselfa policy variable determinedby the central bank,whichcanneutralizeanyeffectthathighergovern-mentborrowingmayhaveoninterestratelevels.butevenifthereweretobeariseinthedomesticinterestrate,becausemonetarypolicydoesnotsupporttheincreaseinthepublicdebt,debt-financedgovernmentspendingwouldcauseaggregatedemandtogrow,andthiswouldencouragetheprivatesectortoinvestinadditionalproductivecapacity.

The idea that an increase in thefiscal deficitwill restrain current private spending, because itcreatesanexpectationofanincreaseinthetaxratetoenabletheStatetomakenetdebtrepaymentsinthe future, ignores thedynamicsofpublicdebt inagrowingeconomy.First,publicdebtthatreachesmaturity is usually replaced by newdebt for thefinancingofnewexpenditure,andtheneedforanetdebt repayment only occurs in exceptional cases.in this respect,sovereigndebtdiffers fromthatofprivateagents,sinceStatesaresupposedtolastfor-ever.Moreimportantly,acredit-financedincreaseinpublicexpenditurewillgeneratenewdemandandgreateroutput,whichinturnwillboostbothprivateincomeandfiscalrevenuesataconstantaveragetax

rate.insuchasituation,itismorelikelythathigherpublicexpenditurewillraiseprivatedemandratherthanlowerit.

Theseconsiderationsdonotimply,ofcourse,that debt financing of public expenditure has nolimits. indeed, an important issue inpublic sectorfinancingindevelopingcountriesandintheassess-mentoffiscalspacerelatestotherisksinvolvedinthe accumulation of public debt.These risks arerelated tofluctuations in economic growth and tomovements in the interest rate on the public debtthatarebeyondthecontrolofthedebtorgovernment,especiallywhenthedebtisdenominatedinforeigncurrency(seealsochapteriiiofthisReport).Thisisoneofthereasonswhyalimitforpublicindebted-nessisdifficulttodetermine.Anotherreasonisthateconomicgrowthandtheprimarybudgetbalancearebothpartlyendogenousvariables(i.e.GDPgrowthandtaxrevenuesarethemselvesinfluencedbythesizeofdebt-financedpublicspending).

Still, unsustainablefiscal policies can lead tosovereigndebtcrises.itmaybepreferableforgovern-mentstopayalltheircurrentandcapitalexpenditureout of current revenues.balancedbudget rules orpublic deficit ceilings have theirmerits, but theycan also unnecessarily constrain the potential forcountercyclical fiscal actionwhen current fiscalrevenuesfallandreducetheabilityofgovernmentstofinancepublicfixedcapitalformation.Thelatterisofparticularimportancefordevelopingandtran-sition economies that have considerable need forsubstantialinvestmentsininfrastructure.Therefore,rulesconcerningthepublicsectordeficitshouldnotbeappliedstrictlytoeverysinglebudgetingperiod;rather,theyshouldadoptalongertermperspective.Also,theyshouldtakeintoaccountthepurposesofpubliccreditfinancing.

Regardingthefirstaspect,aruleaccordingtowhichthepublicsectordeficitshouldnotexceedthelong-termtrendgrowthrateoftheeconomywouldallow short-term cyclical variations of the deficit.Sincethetrendgrowthratetendstobesignificantlyhigherindevelopingandtransitioneconomiesthaninthedevelopedcountries,theformercountriesmay,inprinciple,havegreaterscopefordeficitfinancingthanthelatter.Regardingthesecondaspect,itisimportanttobearinmindthatsometypesofspendingareboundtohavelargermultipliereffectsonoverallincomegrowth than others. in addition, theymayhave a

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stronger stimulating effect on private investment.Thesetypesofpublicspendingaremoresuitableforcreditfinancingthanothersandalsoarewellsuitedtoastrategyofdomestic-demand-ledgrowthbecausetheycontributetomaintaining,orevenenlarging,acountry’sfiscalspace.

Arationalapproachiscertainlytofinancecur-rentexpendituresuchasthepaymentofcivilservants’salaries,theconsumptionspendingofpublicentities,andsocialexpenditurefromtaxationandothercur-rentrevenues,exceptincaseswherecredit-financingofsuchexpenditure iswarranted in thecontextofcountercyclicalaction.inthesesituations,themulti-plier effects tend to be higher, so that the deficitwillgenerallycorrectitselfasaresultofhighertaxrevenuefromtheadditionalincomecreatedbytheinitialdeficitspending.

Publicexpenditureforfixedcapitalformationisquitedifferent fromthatofcurrentexpenditure,because, owing to the complementarities betweenprivateandpublicinvestment,ithasastrongpotentialtoincreaseprivateinvestmentoutlaysinadditiontoitsimmediatedemandeffect.inaway,theviabilityofpublicdebtincurredforthefinancingofpublicinvest-mentcanbeviewedinasimilarwayasprivatedebtincurredforthefinancingofprivateinvestment.First,thecreationofdebtisassociatedwiththecreationofnewproductiveassets,andsecond,similartothepay-offofprivateinvestmentthroughtherevenuesgeneratedbytheuseofprivateproductivecapacity,public investmentcanalsobeviewedashavingapay-offintheformofadditionaltaxreceiptsduetoanenlargedtaxbaseresultingfromtheoverallprod-uctivityincreasesgeneratedbypublicinvestment.

Thissuggeststhatarationalapproachwouldbetolimitdebtfinancinginthemediumtermtothelevelofexpenditureforpublicinvestment.Withregardtoborrowinginforeigncurrency,thisshouldbelimitedtomeetingacountry’sactualforeignexchangeneeds(i.e.borrowinginforeigncurrencyonlytotheextentthatpublicinvestmentsrequiretheimportofcapitalgoods,materialandknow-how),orifthereisaper-ceivedneedtoaccumulateforeignexchangereservesoverandabovethataccruingfromcurrentaccountbalancesandautonomouscapitalinflowsthatarenotusedbytheprivatesectorforthefinancingofimports.

if the space for public sector borrowing, asdeterminedbytheseconsiderations,isnotfullyused,

an increase in credit-financed public expendituremaybeconsideredasapossiblemeanstoraisenotonly domestic demand but also domestic supplycapacities.

3. Policies for fostering domestic productivity growth and structural change

(a) Industrial policies

Within a strategy aimed at giving greateremphasistodomesticdemandtodrivegrowthanddevelopment,particularattentionshouldbegiventostrengtheningdomesticsupplycapacities.Thisisnec-essaryinordertoavoidadeteriorationinthebalanceofpaymentsandatradedeficitresultingfromfastergrowth of domestic demand coupledwith slowergrowthofexternaldemand,whichwould increasethedependenceonforeigncapitalinflowstofinancesuch deficits.This is of particular importance forcountriesthathavealargenaturalresourcebasebutarelativelysmallmanufacturingcapacity,becausegovernmentsofthesecountriesmaybetemptedtoseekshort-termwelfaregainsfortheireconomybyusinghighercommodityexportearningstopayforimportsofconsumergoods,withno,orevenadverse,effectsondevelopment.

Policies promoting structural transformationandtechnologicaldynamism31willbenecessarytoovercome the supplyanddemandchallengesaris-ingfromwhatislikelytoremainadifficultexternalenvironmentcharacterizedbyaslowrecoveryandaweakgrowthpathofdevelopedeconomies.

Developing-countryfirmsareoftenconsideredtechnological laggards thathavedifficultysupply-ingproductswith thecharacteristicsdemandedbyconsumers.Thisisclearlytrueforup-marketgoodsproduced for export to developed countries.Anacceleratedandbroadertransferoftechnologyfromdevelopedtodevelopingcountriesremainscriticallyimportantfornarrowingthisgap.Technologytransferrelatingtocapitalgoodsandequipmentalsoremainscruciallyimportant.

However, technological lagsplayaconsider-ablylessimportantrole–ornoneatall–inmeeting

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thedemandsofemergingmiddle-classconsumers.Developing-countryfirmsmay bewell placed tosatisfythedemandsofthesenewconsumers,notonlybyadaptingexistinggoodsandservicestothesecon-sumers’specificneeds,butalso–andperhapsmoreimportantly–bydevelopingnewgoodsandservicestailoredtotheirneedsorpreferences.32inadditiontotechnologicalinnovation,thedevelopmentofnewmarketinganddistributionnetworkscanbecrucialforensuringthatnewproductsreachthenewconsum-ersindomesticmarkets.Developing-countryfirmsmayhaveanadvantageoverdeveloped-countryfirmsinthisrespect,astheyarelikelytopossessvaluablelocalknowledgeforthedevelopmentofappropriatenewdistributionnetworksandmarketingstrategiesforconqueringnewdomesticmarkets.lessaffluentconsumers often live outside the largest cities inplaceswhere reliable, high-quality and network-driven infrastructuremay be scarce, andwheredistribution systemsmaydiffer from those target-ingbetter-offurbanconsumers.Developed-countryfirms,ontheotherhandtendtouse“theirexisting high-end products and services through standarddistributionchannelstotargetthemost affluenttierofcustomersinthelargestcities”(bostonConsultingGroup,2012:3;emphasisadded).33

Anotherissueconcernstheincreasinglyintensecompetitionamongfirmstogainaccesstotheemerg-ingconsumermarketsindevelopingcountries,andthis is likely to increase even further.establisheddeveloped-countryfirms,especiallymultinationals,aretargetingthesenewmiddleclassesaspotentialconsumers,especiallyassluggishdemandgrowthintheirhomemarketsisslowingdowntheirbusinessactivities. in addition to buildingmarketing anddistributionnetworks,developing-countryfirmswillneed to improve their innovation capabilities anddevelopappropriatetechnologiesrapidlytosuccess-fullycompeteandcapturethisnewdemandintheirdomesticmarkets.

Thekindsoftechnologiesneededtosatisfythechangingdemand structures, and themechanismsrequiredtodevelopthem,arelikelytodifferfromthoseassociatedwithlargetechnologicalspurts.Thelatterarebasedonadvancesinscientificunderstand-ingwhichistranslatedbyappliedresearchintothedevelopmentofcommercialproducts.bycontrast,thechangesinmarketconditions,characterizedbypotentiallylargenewmarkets indevelopingcoun-tries,requirestheidentificationof“latentdemand”

(Schmookler,1962)and the“steering”offirms toworkonproblemsorrequirementsspecifictothosenewmarkets(Rosenberg,1969).34Thismeansthatdemandmay drive both the rate and direction ofinnovation,sothatproducers’proximitytomarketsbecomesavaluableasset.

Changesintheproductionstructureofacountryrequiredtomeetnewlyrisingdemandareunlikelytoinvolveasmoothprocess.Thereasonisthatsuchstructuralchanges toprevailingspecializationpat-terns require a different distribution of resourcesacross industries.Governments can use industrialpolicy to encourage this process. indeed, recentyearshaveseenarevivalofthedebateontheroleofindustrialpolicy indevelopment,promptedby therealizationoverthepastdecadethattheWashingtonConsensus,whichexcludedanyrolefor industrialpolicy, had not fulfilled its promises.As a result,developing countries, aswell as some developedcountries, started to look for alternative develop-ment strategies.This search for alternativeswasaccompanied by a revival of interest in classicalideasofeconomicdevelopment,includingrecogni-tionoftheimportanceofbothdomesticdemandandaneconomy’ssectoralstructureforthegenerationoflinkagesandproductivitygrowth.35Thesetendencieshave been spurred by the economic andfinancialcrisisthathasaccentuatedthedebateaboutmarketfailures and the need for institutions and rules togovernmarkets.Moreover,accumulatedevidenceonthecontributionsofinstitutionsandpoliciestosomeofthesuccessesindevelopment(e.g.Fosu,2013)hasbecomeincreasinglydifficulttoignoreanddismiss.Asa result,policymakershavebeenmorewillingto engage in experimentation anddevelopmentofhome-grownsolutions.Manyoftheseexperimentsincludeagooddoseofindustrialpolicy,suchasinbrazil,ChinaandSouthAfrica.36

Thereorientationrequiredtoaddresspost-crisiseconomicchallengesmayalsobeusedinindustrialpolicy to boost developing countries’ engagementinenvironmentallysustainablegrowthstrategies.37However,itisclearthatnotalldevelopingcountriescan develop anduse large-scale greenproductionand technologies for their industrial development.Nevertheless,someopportunitiesexistforearlymov-ersthatshouldnotbedisregarded.Asizeableshareofthefiscalstimuluspackagesadoptedin2008–2009byanumberofcountries,especiallyChinaandtheRepublicofKorea,toaddresstheglobaleconomic

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downturnwasdirectedtogreenmeasuresandinvest-ments.Thesegreenstimuluspackagescorrespondedto5percentofGDPintheRepublicofKoreaandto3percentofGDPinChina.Measuredinabsolutedol-larterms,theUnitedStatesspentabouttwiceasmuchastheRepublicofKorea.YetthisamountcorrespondstoonlyabouthalfofChina’sexpenditure,anditcor-respondstolessthan1percentofGDPintheUnitedStates(barbier,2011).TheRepublicofKoreaandChinaappeartohaverecognizedmoregenerallythatinvestmentsincleanenergytechnologiescanhaveamajorimpactongrowthandemploymentcreation.Forexample,in2009theRepublicofKorealaunchedafive-yearGreenGrowthinvestmentPlan,spendinganadditional$60billiononreducingcarbondepend-enceandonenvironmentalimprovements,withtheaimofcreating1.5–1.8millionjobsandboostingeco-nomicgrowththrough2020(Zelenovskaya,2012).

Sectionbofthischapterhasdiscussed,inaddi-tiontotherepercussionsofshiftsinglobaldemandasaresultofslowergrowthinthedevelopedcountries,theeffectsofcontinuingfastpopulationgrowthonthedemandforfoodandnewclimate-change-relatedchallenges to agricultural production. in the lightof these effects, there is an urgent need inmanydeveloping countries to improveproductivity, andthusinvestment,intheagriculturalsector,whichhasgenerallybeenneglectedoverdecades. increasingagriculturalproductivitydoesnotnecessarilyrequirehuge investments in advanced technologies, butprimarilycatchingupwiththeapplicationofexist-ing technologies.A considerable portion of suchinvestmentneedstotargetbasicinfrastructure,whichcanbeimprovedwiththehelpofpublicworkspro-grammes.Thesewouldalsocreateadditionalincomeandemploymentinruralareas.

(b) Issues concerning natural-resource-rich economies

Thestrongimpactoftheglobalfinancialandeconomic crisis on natural-resource-dependentcountrieshasagaindemonstratedtheneedforthesecountriestoreducetheirdependenceontherevenuesobtainedfromonlyasmallbasketofcommoditiesbydiversifyingtheirproductionandexportstructures.in this context, the transformationof their naturalresourcebaseintophysicalcapitalshouldbecomeakeyobjectiveoftheirdevelopmentstrategies.itwillnotonlygeneratenewemploymentopportunitiesand

increasethepurchasingpowerofallthesegmentsoftheirsocieties,butalsoenlargetheirfiscalspaceinthemediumtolongterm.

Totheextentthatoveralldemandforprimarycommodities remains robust and that commodityprices,broadlyspeaking,plateauatalevelthatexceedsthat in the 1980s and 1990s, natural-resource-richeconomieswillcontinue tobenefit from improvingtermsoftrade.Nevertheless,theyshouldremainalerttothecyclicalityofprices.Moreover,asituationofrelativelyhighcommoditypricesalso implies thatthese countries should not allow the exploitationoftheirnatural-resourcewealthtojeopardizetheirgrowthinthelongterm.Theycanprevent thisbyensuring that the revenuesaccruingfromresourceexploitationareusedforinvestinginnewactivitiesthatspurproductionandexportdiversification.

Thischallengerelatestohowtodealwithtwopotentially offsetting forces: “over the short run,positiveterms-of-tradeshockswillalways(ceteris paribus)raiseGDP,andtheempiricalissueis…[by]howmuch.overthelongrun,however,apositiveterms-of-tradeshockinprimaryproduct-producingcountrieswill reinforce comparative advantage,suck resources into the export sector from otheractivities, and cause deindustrialization” (HadassandWilliamson,2003:640–641).improvementsinthetermsoftradeandtheresultingincreaseingov-ernmentrevenuesshouldbeusedtoreduceincomeinequality and avoid deindustrialization throughpublicinvestmentandtheprovisionofsocialserviceswhichtargetthosesegmentsofthepopulationthatdonotdirectlybenefitfromresourcerevenues.Alsoneededarepoliciesthatspurindustrialproduction,suchasmaintainingacompetitiveexchangerateandpursuingamonetarypolicy thatstimulatesprivateinvestment.TheseissueshavebeendiscussedinsomedetailbyUNCTAD(2012).

(c) Implications for development partnerships

SincethelaunchoftheMillenniumDevelopmentGoals (MDGs) in 2000 and the adoption of theMonterreyConsensusin2002,theglobalpartnershipfordevelopmenthasconcentratedlargelyonthepro-visionofconcessionaldevelopmentassistancewithaviewtoalleviatingpovertyindevelopingcountries.ithasalsofocusedonincreasedaccessfordevelopingcountriestodeveloped-countrymarketswithaview

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 87

to spurring economic development in developingcountriesthroughexport-orientedgrowthstrategies.

Theincreasedprovisionofbothaidandmarketaccesswas closely related to the greater integra-tionofdevelopingcountries,especiallyChina,intoglobalmarkets.Thefocusoftheglobalpartnershipfordevelopmentonaidandmarketaccesshasoftenbeencriticizedforitsneglectofthecrucialimpor-tanceofinvestmentandthecreationandexpansionofproductivesupplycapacities(see,forexample,TDR 2006).Moreover,theonsetoftheGreatRecessioncastsseriousdoubtsonthepertinenceofthisfocusonaidandmarketaccess.itishighlyunlikelythatdonorcountrieswillmeetthetargetsfordevelopmentassistancesetatvariousinternationalsummitsanytimesooninviewoftheirfiscalproblemsassociatedwiththeeffectsoftheGreatRecession.itisalsoclearthattherulesandregulationsoftradeandinvestmentagreements,aswellastheconditionalitiesattachedtoloanagreementswiththeinternationalMonetaryFund(iMF)andtheWorldbank,havereducedthepolicyspaceofdevelopingcountries.Yet,suchpolicyspaceisneededtodevelopthedomesticproductivecapacitiesrequiredtobenefitfromimprovedmarketaccessconditionsandenhancedevelopment.

This shortcoming needs to be redressed byensuringthattheglobalpartnershipfordevelopmenttakesintoaccountthestructuralshiftsthathavebeentakingplacein theworldeconomysincetheearly2000s.oneof these shifts, onwhich this chapterhasfocused,concernsthelikelyemergenceofabout2billionadditionalmiddle-classconsumersoverthenextdecade.Thisshiftcouldbeacceleratedbytheimplementationofadevelopmentstrategythatgivesgreaterimportancethaninthepasttotheexpansionofdomesticdemand.Suchastrategy,ifsuccessful,mayalsoleadtoincreasedpurchasingpoweramongthelowerincomegroupsindevelopingcountries.Thiswillopenupnewopportunitiesfortheenhancementofproductive capacity and economicgrowth.Thequestformarketsharesinthelarge,butonlyslowlygrowingmarkets of developed countries, aswellasintheyetsmall,butrapidlygrowingmarketsindevelopingcountries,willbeassociatedwithgreaterinternationalcompetition. inorder tomanagesuchincreasedcompetition,developingcountriesmayneedtomakefulluseofwhateverpolicyspacetheystillhaveattheirdisposalaftertheconclusionofvariousregional andbilateral trade and investment agree-mentsandtheUruguayRoundtradeagreements.

However,theseshiftsalsohavemuchbroaderimplications. even though the vastly increasedimportanceofdevelopingcountries inglobaleco-nomicgrowth,trade,FDiandcapitalflowsremainsconcentrated in only about a dozen of them, thissystemicchangeopensupnewpossibilities.Forone,itgivesgreaterweighttotheirvoiceandincreasestheir bargaining power as a group for reshapingthe rules and institutions that constrain the policyspaceavailable tocountries thatare latecomers todevelopment.ThereisalsogreaterscopeforregionalandSouth-Southcooperationinmanyspheresandthroughdifferentformsofinstitutionalarrangementsthatpoolmarketsandresourcesfordevelopment.butperhapsmostimportantly,theinternationalcommu-nityshouldnowrealizethat,withthestructuralshiftsintheworldeconomy,“itistimetomoveawayfromunidirectionalorasymmetricalrelationships”sothatdevelopment partnerships betweendeveloped anddevelopingcountries,aswellasamongdevelopingcountries,movetowardsagreaterconsiderationof“the logicand thespiritof internationalcollectiveaction”(Nayyar,2012:23).

4. Conclusions

Developingandtransitioneconomiesarelikelytofacesluggishimportdemandfortheirgoodsasaresultofaprotractedperiodofslowgrowthindevel-opedcountries.Thus,forpolicymakersintheformerset of countries, reverting to the pre-crisis policystancewithitsemphasisonexport-orientedgrowthisnotanoption.Theexternaleconomicenvironmentthatbenefitedsuchagrowthstrategy,especiallydur-ingthefiveyearspriortotheGreatRecession,wasbuiltonunsustainableglobaldemandandfinancingpatterns.Countercyclicalmacroeconomic policiescanboostgrowthforsometime,butwilleventuallyresult infiscal or balance-of-payments constraintsunlesstheyarefollowedbypoliciesthatadoptamorecomprehensiveandlongertermperspective.

Alongertermpolicytosupportrapidandsus-tainedeconomicgrowthindevelopingandtransitioneconomiesinthevastlychangingglobalenvironmentwill need to consider adopting amore balancedgrowthstrategythatgivesagreaterroletodomesticdemandtocomplementexternaldemand.Thepos-sibilityofrapidlyundertakingsuchashiftinstrategy

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andthepolicymixneededtosupportthisshiftwilllargelydependontheextent towhichthesectoralstructureofdomesticproductionisdelinkedfromthatofdomesticdemand.This,inturn,willbeinfluencedbythesizeofthedomesticmarket.Whilenatural-resource-richcountriesmaybeabletocontinuetobenefitfromhistoricallyhighcommodityprices,theyshouldensurethattheresultingrevenuesareusedforinvestinginnewactivitiesthatspurproductionandexportdiversification.

Particularly in countrieswheremanufacturesalreadyaccountforasizeableshareofproduction,ashiftingrowthstrategyshouldseektoachieveanappropriatebalancebetweenincreasesinhouseholdconsumption, private investment and public sec-tor expenditure.The specificsof this balancewilllargelydependon thecircumstancesof individualcountries,but ingeneral itwillrequireanewper-spectiveontheroleofwagesandthepublicsectorinthedevelopmentprocess.export-orientedgrowthstrategies emphasize the cost aspect ofwages; bycontrast,amoredomestic-demand-orientedstrategywouldemphasizetheincomeaspectsofwages,asitwouldbebasedonhouseholdspendingasthelargestcomponentofdomesticdemand.employmentcrea-tioncombinedwithwagegrowththatisinlinewithproductivitygrowthshouldcreatesufficientdomesticdemandtofullyutilizegrowingproductivecapacitieswithouthavingtorelyoncontinuedexportgrowth.Household spending could alsobe encouragedbyfacilitating access to consumer credit.However,suchanapproachisrisky,asamplydemonstratedbyrecentexperiencesinanumberofdevelopedcoun-tries.Thepublicsectorcanfurtherboostdomestic

demandbyincreasingpublicemploymentorunder-takinginvestment,whichisoftenapreconditionforprivate investment.inaddition,changesin thetaxstructureandthecompositionofpublicexpenditureandtransferscouldshapethedistributionofpurchas-ing power in the economy towards those incomegroupsthatspendalargershareoftheirincomeonconsumption.

increased aggregate demand fromhouseholdconsumptionandthepublicsectorwouldprovideanincentivetoentrepreneurstoinvestinincreasingrealproductivecapacity.industrialpolicycouldsupporttheassociatedinvestmentdecisionssothatthesecto-ralallocationofinvestmentbettercorrespondstothenewlyemergingpatternsofdomesticdemand.Giventheir better knowledge of localmarkets and localpreferences,developing-countryenterprisesmaywellhaveanadvantageoverforeignonesincateringtothesenewdemandpatterns.Theycouldthuspreventtheriseindomesticdemandfromcausingasurgeinimportsfromdevelopedcountries.

Perhapsmostimportantly,distinctfromexport-ledgrowth,agrowthstrategywithagreaterrolefordomesticdemandcanbepursuedbymanycountriessimultaneously,includingeventhelargest,withoutcausingadversespillovereffectsonothercountriesandwithout inducingwage and tax competition.indeed,ifmanydevelopingandtransitioneconomieswere tomove towards amore balanced growthstrategy simultaneously, their economies couldbecomemarkets for each other, spurring regionalandSouth-South trade,and thus furthergrowth inallofthem.

Towards More Balanced Growth: A Greater Role for Domestic Demand in Development Strategies 89

1 evidenceinchart2.1suggeststhatChinasufferedonlymildlyfromthetradecollapsein2008–2009.However,thedataforChinaprobablyunderreportthe actual effects by a sizeablemargin. it iswellknownthatmuchofChina’sexportsarerecordedastransshipmentsandre-exportsfromHongKong,SpecialAdministrativeRegion ofChina (HongKong,SAR)(e.g.FerrantinoandWang,2008),forwhichtheadverseeffectshowninchart2.1isverystrong.

2 For amore detailed account of the contributionof different product categories to changes in thetermsoftradeinselecteddevelopingcountries,seeUNCTAD,2012:17–19.

3 StandardChartered (2010:1) defines a supercycleingeneralasa“periodofhistoricallyhighglobalgrowth, lasting a generation ormore, driven byincreasingtrade,highratesofinvestment,urbaniza-tionandtechnologicalinnovationcharacterizedbytheemergenceoflarge,neweconomies,firstseeninhighcatch-upgrowthratesacrosstheemergingworld”.

4 basedontheUnitedNationsPopulationDivision’smedium-variant estimates (seeWorld Population Prospects,availableat:http://esa.un.org/wpp/).

5 Morerecently,Chinahasevensurprisedthemarketsbyimportingrice(Wall Street Journal,Chinariceimportsunsettlemarket,7January2013).oeCD-FAo (2013) also reports considerable growth inChina’simportsofsomeothercommoditiesinrecentyears,includingpigmeat,dairyproducts,maizeandsugar.

6 See, for instance,Wall Street Journal, “China tospeedup reformofhukousystem”,18December2012.

7 UNCTAD secretariat calculations, based on datafromUSDA,backgroundprofileoncorn,at:http://www.ers.usda.gov/topics/crops/corn/background.aspx(accessedJune2013).

8 See, for instance,Wall Street Journal, “Africanoil exports plunge amid swellingU.S. output”,28February2013.

9 Foramoredetailedanalysisofthepotentialimplica-tionsofshaleoil,seeHelbling,2013;Maugeri,2012;Morseetal.,2012;andPWC,2013.

10 SeeFarookiandKaplinsky(2012)foramoredetaileddiscussiononcommoditysupplyresponseandpro-ductionconstraints.

11 AsdiscussedinmoredetaillaterinthisReport,thiscouldalsoexertdownwardpressureon thepricesofcertaininternationallytradedmanufactures,pos-siblycausingproducersof suchgoods touseanyproductivity increase to reduce unit labour costs.This,inturn,wouldhaveanegativeimpactonthepurchasing power ofworkers in these industries,and thus on domestic demandgrowth, especiallyin developing countries that continue to pursue adevelopmentstrategythatreliesonexport-orientedgrowthoftheirmanufacturingindustries.

12 Durable consumer goods include commoditieswhich have an expected life span ofmore thanthreeyearsandareofrelativelyhighvalue,suchasrefrigeratorsandwashingmachines,togetherwithothercommoditieswithausefullifeofthreeyearsormore,suchasaudio-visualproducts.Semi-durableconsumergoodsincludecommoditieswhichhaveanexpectedlifespanofmorethanoneyearbutlessthanthreeyearsandareofrelativelylowervalue,suchas textiles,apparel, footwearand toys.Non-durableconsumergoodsincludecommoditieswithanexpectedlifespanoflessthanoneyear,suchaspartsofapparelandpharmaceuticals.These threecategoriescombinedaccountedfor55percentofChina’stotalexportstotheUnitedStatesin2007.

13 UnitedStates imports of automobiles (chart 2.4)havealsoreboundedtotheirpre-crisisdynamism.However,developingcountriesaccountforonlyasmallshareofthoseimports.

14 Thisassumptionrelatestowhateconomistsrefertoas“homotheticpreferences”.

15 ThestructureofthistheoreticalapproachissimilartothetheoryofconsumptionproposedbyPasinetti(1981) in that it is based on a generalization ofengel’slaw(i.e.anincome-drivennon-proportionalexpansionofdemandandlearningprocessesbycon-sumerswhichcausethemtoaltertheirpreferences).However,ratherthanemphasizingdemand,Pasinettibasedtheselearningprocessesontheappearanceofnewproductsthatresultfromtechnicalprogressonthesupplyside.

Notes

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16 indeed,Murphy,ShleiferandVishny (1989:538)view themiddle class as a necessary “source ofbuyingpowerfordomesticmanufacturers”.

17 See the annex to this chapter for amoredetaileddiscussionofthesemechanisms.

18 Forempiricalevidencesupportingtheseassumptionswithregardtopassengercars,seeDargay,GatelyandSommer,2007.

19 Theinternationaldollarisahypotheticalcurrencyunitthatisgenerallyexpressedintermsofconstantpricesinacertainbaseyearandhasthesamepur-chasingpowerasthedollarintheUnitedStatesinthatyear.Forthevariousissuesconcerningtheuseofpurchasingpowerparityandinternationalaver-agepricesofcommoditiestocalculatetheunit,seeUnitedNations,1992.

20 “italy’s per capita incomewas used as the upperthresholdbecauseitwasthecountrywiththelowestincomeamongtheG7;brazil’spercapitaincomecorrespondedtotheofficialpovertylineusedinrichcountriesliketheUSandGermany(about$PPP10percapitaperday)”(bussoloetal.,2011:14).

21 TheestimatesinKharas(2010)arebasedonprojec-tionsofGDPfortheperiod2008–2050,whereGDPisafunctionoftheaccumulationoflabour(basedonprospectsfortheevolutionoftheworking-agepopulation provided by theUnitedNations) andcapital(basedontheaverageinvestmentratefortheperiod1995–2005),aswellastotalfactorproductiv-itygrowth(basedonhistoriclong-termtechnologygrowth and an assumed process of convergencewiththeUnitedStates).Allthesearecombinedwithprojectionsoflong-termexchange-ratemovementsand purchasing-power conversion rates, aswellaswithdataon incomedistributionandestimatesofmeanconsumptionpercapita.Theestimatesinbussoloetal.(2011)resultfromabroadlysimilarmethodology, though this focuses on the impactofeconomicgrowthinChinaandindiaonglobalgrowthanddistribution,andemploysgrowthratesthataredisaggregatedbyeconomicsectorinordertobettermodeltheevolutionofincomedistribution.Whilethemethodologicalapproachesusedinthesetwostudiesmaybe subject tocriticism, theyare,nevertheless, useful for illustrating the key issueraisedhere, namely that the developing countriesareprogressivelyaccounting for a larger shareofglobalconsumption.

22 Thecorrelationbetweenthegrowthoflabourincomeandthegrowthofhouseholdconsumptionissignifi-cantatthe10-percentlevelofconfidence.

23 ThesefindingsaresupportedbyacomprehensivestudybyonaranandGalanis(2012)whichshowsthat,takingtheworldeconomyasawhole,asimul-taneousandcontinuingdecline in thewageshareleadstoaslowdownofglobalgrowth.Furthermore,taking countries individually in amore detailed

investigationof16membersoftheG20,theauthorsobservethat9ofthemshowapositivecorrelationbetweenwagegrowthandGDPgrowth.Moreover,4oftheremaining7economieswhichshownegativecorrelationsbetweenwagegrowthandGDPgrowthwhentakenindividually,effectivelyregisterlowergrowthwhenthewagesharesofalltheeconomiesfallsimultaneously.

24 Therecentdebateonhigheraggregatedemandthatresultsfromanincreaseingovernmentspending(i.e.“themultipliereffect”)indicatesthatthiseffectisgenerallyhigher–andexceedsunity–inrecessionsthaninmorenormaltimes.

25 itshouldbenotedthatanyschemethatattemptstoincreasethesalesanduseofprivatecarsmaycon-flictwithurbanizationstrategiesthatgiveprioritytoexpandingpublictransportsystems.

26 JPMorgan,“Thailand:autosslowingbutdomesticdemandnotstalling”,Global Data Watch,22March2013.

27 Revenue fromcapital investments (e.g. dividends)mayalsoboostdisposablepersonalincome.However,suchsourcesareunlikelytobeofmuchsignificancetomostof the segmentsof thepopulation that aretargetedasagentsofincreasedhouseholdconsump-tionspending(i.e.lowerandmiddle-incomeclasses).

28 insomecountries,suchasbrazil,therapidgrowthofhouseholdcredithasalsobeenaffectedbycapitalinflows (which have provided ample liquidity tobanks)andbythedevelopmentofdomesticcreditmarkets.ChapteriiiofthisReportaddressestheseissuesindetail.

29 R.Colitt, “brazil consumer default rate drops tolowestlevelin16months”,bloomberg,26March2013; available at: http://www.bloomberg.com/news/2013-04-26/brazil-consumer-default-rate-drops-to-lowest-level-in-16-months.html.

30 Thistrade-offispartofthedebate(furtherdiscussedinchapteriii)aboutwhethercentralbanksshouldbeconcernedexclusivelywithpricestability(e.g.bypursuinginflationtargeting),orwhethertheyshouldalsoberesponsibleformaintainingfinancialsectorstability,whichmayimplypreventingtheformationofassetpricebubbles.Acentralbankthatpursuesinflation targetingwouldmaintain low interestrateswhentheinflationrateislow.Thelowinterestrates,inturn,wouldallowhouseholdstocontainanincreaseintheirdebtburden,eveniftheiroutstand-ingdebt increases.However, a sudden change inriskperception,caused,forexample,bytheburstingofanassetpricebubble,willleadtoasuddenandsizeableriseintheinterestrateonoutstandingdebt,withensuingadverseeffectsonspending.

31 itisclearthattheneedfortechnologicaldynamismdoesnotconcernonlymanufacturing,whichisthefocus of this section.However, the primary andservices sectorsoftenprovide feworonlypoorly

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paidjobs,andproductivitygrowthinthesesectorsusuallylagsbehindthatinmanufacturing.

32 Arelatedissueconcernstheimpactofashiftofmajorsegmentsoftheendmarketsformanufacturesfromdevelopedtodevelopingcountriesonthefunctioningof global supply chains. industrialization throughparticipationandupgradinginglobalvaluechainshasplayedacrucialroleinmanycountries’export-orienteddevelopmentstrategiesover thepast twodecades.However, empirical evidence suggeststhatsupportingexporters’domesticembeddedness,ratherthanfavouringparticipationinsupplychains,iscrucialforproductupgradingandforachievingprofitability and value added (see, for example,Jarreau and Poncet, 2012; andManova andYu,2012).Theexistenceofsuchbackwardlinkagesmaybecomeevenmore importantfor theresilienceofdevelopingcountries,assomesegmentsoftheendmarketsforconsumergoodsshifttotheirdomesticeconomies(i.e.closertotheproductionsitesofsuchgoods),therebyalsoincreasingtheforwardlinkagesofsuchproductionsites.Thismayeventuallyprovideanopportunityfordeveloping-countryfirmstoleadsupply chains, rather thanmerely integrate intoexistingchains,anddevelopbytryingtoincreasethevalue-addedcontentoftheiractivities.

33 it is interesting to note in this context that somemarketanalystshavestartedtowarnevenWesternproducersofluxurygoodsthatthetimemaysoon

be overwhen luxury goods embodying famili-ar French and italian cultural values sell well,and that theywill increasingly need to offer lessstandardized items,which take account of valuesembedded in the cultures of their destinationmarkets(V.Accary,“lemarchéduluxedanslespaysémergentsestentraindechanger,ilfauts’yadapter!”,Le Monde Economie,25March2013;available at:. http://www.lemonde.fr/economie/article/2013/03/25/le-marche-du-luxe-dans-les-pays-emergents-est-en-train-de-changer-il-faut-s-y-adapter_1853658_3234.html).

34 Miles (2010:3)providesadetailed reviewof the“schismbetweenSchumpeter’semphasisontechnol-ogybreakthroughsandSchmookler’sstressoninno-vationrespondingtothepullofmarketdemand.”

35 boththeseissueswerediscussedindetailinTDRs 2003and2006.

36 Theseexperimentsarenotonlyrelatedtothedevel-opment of domestic supply capabilities requiredforsatisfyinggrowingdomesticconsumerdemand,which is the focus here; they also concern issuesrelated to global supply chains,where industrialpolicyinvolvesregulatinglinkstotheglobalecono-my,suchasthroughtrade,FDiandexchangerates(see,forexample,Milberg,JiangandGereffi,2013).

37 industrialpolicycanalsobeavehicle forgreaterregionalintegration,especiallyforsmallcountries(forUruguay,seeTorres,2013).

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Shifting Growth Strategies: Main Implications and Challenges 95

Manydevelopingcountrieshavepursuedexport-orientedgrowthstrategiesoverthepastthreedecades.Thesuccessof suchstrategiesdependson rapidlygrowingglobaldemandandtheidentificationofnewexportmarkets or the expansionof existingones,combinedwiththeabilityofanexportingcountrytoentermarketsegmentswithhighgrowthandpotentialforproductivitygrowth.

With theonsetof theglobalcrisis, suchstrat-egies are no longer viable. Demand growth in

developed-countrymarkets, especially theUnitedStatesandeurope,hasdeclinedsharply.Despiteanearlyswiftrebound,itiswidelyexpectedthatslowgrowthinthedevelopedcountrieswillreduceexportopportunitiestothesecountriesforalongtime.Thisraises the question as towhether developing andtransitioneconomies,andespeciallythelargeonesamongthem,canshiftfromanexport-orientedtoamore domestic-demand-oriented growth strategy.Thisannexaddresseswhatsuchashiftwouldentail.

Annex to chapter II

ShIFTING GROwTh STRATEGIES: MAIN IMPLICATIONS AND ChALLENGES

Theorientationofacountry’sgrowthstrategy,whethermore towards exports ormore towardsdomesticdemand,impliesdifferencesinthegrowthcontributionofthevariouselementsofthenationalincomeaccountingidentityexpressedas:

Y=C+I+G+(X-M) (1)

whereacountry’soutput(Y)isthesumofhouseholdconsumption expenditure (C), investment (I),governmentexpenditure(G)andthecurrent-account

balance,i.e.thedifferencebetweenexports(X)andimports(M).1eachelementontheright-handsideoftheequationhastwocomponents,oneofwhichisautonomousandtheotherafunctionofnationalincome,whichinturnequalsoutput(Y).Anexport-orientedgrowthstrategywillpayparticularattentionto the relationship between exports and imports,whiletheotherthreecomponentswillbeofgreaterinterestinamoredomestic-demand-orientedgrowthstrategy.

1. The national income accounting identity and economic growth

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Mostmodels of economic growth pay littleattentiontothevariouscomponentsofthenationalincomeaccountingidentity.Suchmodelsaresupply-driven, with output growth being a function offactor inputs and factor productivity.Aggregatedemandforoutputisassumedtobesufficientforfullutilizationofcapacity.Tradeistheonecomponentoftheaccountingidentitythatenterssupply-basedgrowth analyses, sometimes through the terms oftrade(definedastheratioofexportpricestoimportprices), butmore usually on the assumption that“tradeopenness”contributestocapitalaccumulationor productivity growth.Different studiesmeasureopenness differently: some through tariff rates ornon-tariffbarriers,butmostcommonlyassomeratioof tradeflows tooutput (HarrisonandRodriguez-Clare,2010).

Fromsuchasupply-basedperspective,“export-oriented growth” refers to a high ratio of exportsandimportsrelativetooutput((X+M)/Y),i.e.beingvery open to trade.Ahighdegree of openness totrademaycontribute togrowth if imported inputsaremoreproductivethandomesticinputs,orifthereare technological spillovers or other externalitiesfrom exporting or importing. The literature onglobalvaluechainssuggests thatahighdegreeoftradeopennesswillhaveapositiveeffectongrowth,particularlyincountriesthatexportalargeproportionofmanufacturesandsucceedin“movingupthevaluechain”,i.e.theyincreasethevalue-addedcontentoftheirexports.Ahighdegreeoftradeopennessisalsoofmicroeconomicrelevance,sinceitdeterminesthedegree towhich thesectoralstructureofdomesticproductionisdelinkedfromthatofdomesticdemand.Thisgapwillbeparticularlywideforcountriesthatexportahighproportionofprimarycommodities;butitwillalsobesubstantialforcountriesthatproducegoods, such as consumer electronics,which fewdomesticconsumerscanafford.

The national income accounting identity isof immediate relevance for themacroeconomiccausation of growth if it is considered from thedemand side. From a demand-based perspective,“export-orientedgrowth”referstoalargedifferencebetween exports and imports relative to output((X-M)/Y), i.e. running a large trade surplus.Thereasonwhythisperspectiveconsidersthedegreeofopennessasbeinglessrelevantforgrowthis that,focusingontheshareofhouseholdconsumptionin

output,thenationalincomeaccountingidentitycanberearrangedas:

Y

MXY

GIYC )()(

1−

−+

−=

(2)

where anygiven share of household consumptioninoutput(i.e.C/Y)iscompatiblewithanunlimitedrangeofvaluesoftradeopenness(i.e.(X+M)/Y).Acountry canhave a high share of consumption inoutputandstillexportmostofitsoutput.bycontrast,thelargerthetradesurplus(i.e.(X-M)/Y),thelargerwillbethegrowthcontributionofexports,andthesmallerwill be the contributions of the domesticdemandelements(i.e.C,IandG)requiredtoattainagivenrateofgrowth.

A related demand-basedmeaning of export-orientedgrowthemphasizestheroleofthebalance-of-payments constraint in limiting output growth.Fromthisperspective,exportorientationisrelevantforacountry’sgrowthstrategyforatleasttworeasons(Thirlwall, 2002: 53).2 First, exports are the onlytrulyautonomouscomponentofdemand,i.e.theyareunrelatedtothecurrentlevelofnationalincome.Themajorsharesofhouseholdconsumption,governmentexpenditureandinvestmentdemandaredependentonincome.Second,exportsaretheonlycomponentofdemandwhoserevenuesaccrueinforeigncurrency,andcan thereforepayfor the import requirementsofgrowth.Growthdrivenbyconsumption,invest-mentorgovernmentexpendituremaybeviableforashorttime,buttheimportcontentofeachofthesecomponentsofdemandwillneedtobebalancedbyexports.ofcourse,suchbalancingisnotnecessaryif a country accumulates external debt, absorbs arisingamountofnetcapitalinflowsorletstherealexchangeratedepreciate.However,thelengthoftimeanyofthesethreestrategiescanbepursueddependsverymuchon the external economic environment(e.g.thesizeoftherateofinterestoninternationalcapitalmarkets),andtheycanquicklyspiralintoabalance-of-paymentscrisis.

Atwhatpointintimethebalance-of-paymentsconstraintisfeltdependsontheimportcontentofthevariouscomponentsofaggregatedemand(YD)whichareapartofleakage,i.e.thefractionofachangeinnationalincomethatisnotspentoncurrentdomesticproduction,but insteadsaved (s),paid in taxes (t)

Shifting Growth Strategies: Main Implications and Challenges 97

orspentonimports(m).Thus,thedeterminationofaggregatedemandcanbeschematicallyexpressedas:

mtsXGI

YD ++

++=

(3)

Aspecialcaseofthisequationisthedynamicversion ofHarrod’s foreign trademultiplier. inthis case, household consumption, investment,andgovernment expenditure haveno autonomouselementandtradeisassumedtobebalancedinthelong run (i.e.X=M), because all output is eitherconsumedorexportedandallincomeisconsumedeither on domestic goods or imports.Thismeansthat savings and taxesmust equal investment andgovernment expenditure (i.e. s+t=I+G).Thus, thegrowthrateofcountryi(gi)isdeterminedbywhatisknownas“Thirlwall’slaw”,andexpressedas:

i

ii

zg π

ε=

(4)

whereεiistheworld’sincomeelasticityofdemandforexportsfromcountryi,πiistheincomeelasticityofdemandforimportsbycountryi,andzistherateofworldincomegrowth(Thirlwall,1979).Accordingtoequation(4),acountry’sgrowthrateisdeterminedbytheratioofexportgrowthtotheincomeelasticityofdemandfor imports.Thegrowthofacountry’sexports(xi)–withxi=εiz–isdeterminedbywhatisgoingonintherestoftheworld.it influencesthegrowthofYD,andhencethegrowthofoutput(intheshortrunviatherateofcapacityuseandinthelongrunbymotivatingtheexpansionofcapacity).3Giventhecurrentsituationofslowgrowthindevelopingcountries’mainexportmarkets,equation(4)impliesthatdevelopingcountries’economicgrowthwillbeconstrainedbyaslowdownintheexpansionoftheirexports.

in addition to the impact on the expansionof exports taken as a bundle, the extent towhichan exporting country’s growth rate is affected byeconomicgrowthintherestoftheworldalsodependsonitspatternofspecialization.4ifacountryexportsgoodsandserviceswitharelativelylargepotentialforinnovationandtechnologicalupgrading,outputgrowth couldbeboosted through improved factorproductivityor through an increase in the incomeelasticityofdemandstemmingfrominnovation-basedimprovementsinthequalityofgoods.ifacountry

exportsfromsectorswithmorerapidinternationaldemandgrowth,itcouldbenefitfromalargerincomeelasticityofdemand for its exports, thusboostingoutputgrowthbyattainingahigherε/πratio.Sectorsinwhichthereissignificantpotentialforinnovationmaybecalled“supplydynamic”,whilesectorsthatbenefitfromarapidgrowthofinternationaldemandmay be called “demand dynamic” sectors.Andthereisasignificantdegreeofoverlapbetweenthetwo groups (Mayer et al., 2003).Comparedwithprimary commodities,manufactures are usuallyconsidered as having both greater potential forinnovation and technological upgrading aswellas better international demandprospects.export-orientedindustrializationisastrategythatexploitsthis overlap during periods of favourable exportopportunitieswithaviewtoincreasingacountry’sε/π ratio (especially through an increase in ε) andthereforeitsgrowthrate.ontheotherhand,thisalsomeansthat,inthecurrentcontext,theadverseimpactofslowgrowthindevelopedcountriesislikelytobegreaterondevelopingcountriesthatpursueanexport-orientedgrowthstrategythatreliesmainlyonexportsofmanufacturesthanondevelopingcountrieswhosesimilarstrategyreliesmainlyonexportsofprimarycommodities.

The argumentmade in this chapter adopts ademand-sideperspectivemainlybecauseitfacilitatesanexaminationoftheprocessesinvolvedinshiftingtheorientationofacountry’sgrowthstrategyfromonecomponentofdemand(i.e.exports)toanother(i.e. domesticdemand).but takingademand-sideperspectiveongrowthalsoallowsestablishingalinkbetweentheorientationofgrowthstrategiesandthecurrentdebateonrebalancing,muchofwhichrelatestotheshareofhouseholdconsumptioninaggregatedemand.TheG20leaders’Statement(2009)atthePittsburghSummit called for a rotation of globaldemandfromcountrieswithacurrentaccountdeficit(especially theUnited States) towards countrieswithacurrentaccountsurplus(suchasChinaandGermany),where domestic expenditure in deficitcountrieswould no longer exceed their incomebutrapidglobalgrowthwouldbemaintained.Thisis because surplus countrieswould, at least for aperiodoftime,recordaccelerateddomesticdemandgrowthinexcessoftheirincome.Finally,someofthosecountrieswhoseexportopportunitiesmaybeadversely affectedby a prolongedperiodof slowgrowthindevelopedeconomiesmayriskfallinginto

Trade and Development Report, 201398

theso-called“middle-incometrap”,asthedeclineintheirmanufacturedexportsmaysignificantlyslowdowneconomicgrowth.itisgenerallyarguedthatthose countrieswill increasingly need to rely on

innovation(i.e.investmentinthenationalaccountingidentity),andhouseholdconsumptionexpenditureinordertocontinuetocatchupwiththeincomelevelsandstandardsoflivingofthedevelopedcountries.

Considered froma demand-side perspective,therearethreemainchallengesinswitchingfromagrowthstrategybasedonexportstoonebasedmoreondomesticdemand.onerelatestothesizeofthedomesticmarket.According to equation (2), theincreaseinthesumofC,IandGmustbesufficientlylarge to compensate for the decline in the tradesurpluscausedbyafallinexportswithouthavinganegativeimpactongrowth.WithΔdenotingchanges,thiscanbeexpressedas:

YMX

YGIC )()( −∆

−=++∆

(5)

Concentratingonhouseholdconsumption,theclaimthatasizeablesegmentof thepopulation insomeofthemostpopulousdevelopingandtransitioneconomies (e.g. brazil, China and the RussianFederation)hasattainedmiddle-classstatus,andthatthisstatusisnotfarfrombeingattainedinsomeothereconomiesaswell(suchasindiaandindonesia)(e.g.bussoloetal.,2011;Kharas,2010)suggeststhattheseeconomieshaveasufficientlylargedomesticmarketforrisinghouseholdexpendituretocompensateforatleastamajorpartofanydeclineinexportdemandduetolowgrowthindevelopedcountries.

The second challenge concerns the risk thata switch in growth strategywill rapidly becomeunsustainablebytriggeringasurgeinimportsandensuingbalance-of-paymentsproblems.5Differencesintheimportintensityofthedifferentcomponentsof

aggregatedemandimplythattherelativeimportanceofC,GandIdeterminestheevolutionofimports.Rewriting equation (1),withmC,mI,mG, andmXdenotingtheimportintensityofC,I,G,andX,leadsto

Y=(C-mCC)+(I-mII)+(G-mGG)+(X-mXX) (6)

whichshowsthatthesedifferencesimplythatchangesinthecompositionofacountry’saggregatedemandwill cause significant changes in imports,whichoccurevenifthelevelofnationalaggregatedemanddoesnotchange.Statisticalevidenceindicatesthatinmostcountriestheimportintensitiesofexportsandinvestmentexceedthatofconsumption,andthattheimportintensityofhouseholdconsumptionexceedsthat of government consumption, since the latterincludes a large proportion of non-tradables suchasservices(e.g.bussièreetal.,2011).Avariationin the importcontentsof thedifferentelementsofaggregatedemandimpliesthatchangesinthetradebalancehavedifferentindirectimpactsongrowth.6AsnotedbyMcCombie(1985:63),“anincreaseinexports allows other autonomous expenditures tobe increaseduntil incomehas risenby enough toinduceanincreaseinimportsequivalenttotheinitialincreaseinexports.”

Maintaining some export growthwillmostlikelybenecessaryinordertofinancetheimportsofprimarycommoditiesandcapitalgoodsrequiredfor ongoingurbanization and for an expansion of

2. A demand-side perspective on the transition from an export-oriented to a more domestic-demand-orientated growth strategy

Shifting Growth Strategies: Main Implications and Challenges 99

domesticproductivecapacity.inthecurrentcontext,maintainingsomeexportgrowthmaybemorefea-sible for developing-country exporters of primarycommodities, especially energy. For developingcountriesexportingmanufacturedgoodstodevelopedcountries,itwilldependontheevolutionofimportdemand in developed countries, butwould prob-ablyalsorequireseekingotherdestinationmarkets,mainly in developing countrieswhere consump-tion expenditure is increasing.Maintaining exportgrowthcouldalsobeachievedby the inclusionofmoresophisticatedgoodsintheexportbasket,suchasthroughupgradinginglobalvaluechainswhichcould both raise exports and reduce imports, butmuchofthescopefordoingsowillalsodependontheevolutionofimportdemandindevelopedcoun-tries.However,itmustbeborneinmindthatfromtheperspectiveoftheglobaleconomy,anycountry’stradesurplusmustbeabsorbedbyacommensurategrowthinothercountries’imports.

The third challenge relates to the fact that,unlike exports, the bulk of the other componentsof aggregate demand (i.e. household consumptionexpenditure, government expenditure and invest-ment) is not autonomous, but induced by income(e.g.C=cY,wherecisthemarginalpropensitytocon-sume).Thismeansthatforashiftingrowthstrategytobesustainable,aninitialincreaseinexpenditurein the, usually small, autonomous segments ofC,GandImusttriggeranincreaseinexpenditureinthose segmentsofC,G and I that are inducedbyincome,andincomeitselfmustbegeneratedintheprocess.Theremainderofthisannexdiscusseshowtheautonomoussegmentsofthevariouscomponentsofdomesticdemandcanbeincreased,andhowsuchincreases can create income that, in turn,wouldenablegrowthinthosesegmentsthatareafunctionofincome.

Somepartofgovernmentexpenditureisautono-mous, and canbefinancedby issuinggovernmentbondsorimposinghighertaxrates.However,muchofgovernmentexpenditureandrevenueisendogenous(such as payments for unemployment benefits andtaxreceipts),andisthereforeafunctionofincome.The income effects of an increase in governmentexpenditure,inturn,dependonitsmultipliereffectsand on the degree of internationally coordinatedfiscalexpansion.Thereisanongoingdebateaboutthesizeof themultipliereffect,but it isgenerallyagreedtobehigherinaslumpthaninmorenormal

times(blanchardandleigh,2013).in2008–2009,simultaneousfiscalexpansionplayedacrucialroleincompensating for theadversegrowtheffectsofdecliningexportopportunitiesfordevelopingcoun-tries.However, these countriesmaynot have thenecessaryfiscalspacetoenabletheadoptionofsuchmeasures a second time (or evenon a continuousbasisoveragivenperiod).Moreover,thereareques-tionsastohowmuchofacountry’sfiscalexpansionundertakenindividuallyspillsovertoothercountriesthroughrisingimports.Coordinatedfiscalexpansionwould greatly bolster the growth prospects of allparticipating countries, but this requires consider-ablesolidarityamongStatesandpeoples,whichisunlikelyintheforeseeablefuture.

investmentalsohasanautonomouscomponent,particularly public investment in infrastructureand housing.However, the bulk of investment isendogenousandisdeterminedbytheopportunitycostofcapital.Thisismainlyafunctionoftheshort-terminterestratesetbythecentralbankandexpectationsoffuturegrowthofsales.ifentrepreneursexpectastrong and sustained increase indemand forwhattheyproduce,theywillengageinlargeinvestmentexpenditures financed, for example, through thecreation of liquidity by commercial banks.Thismeansthatacountry’soverallshareofinvestmentinGDPmustbecompatiblewithitsoverallshareofconsumptioninGDPtoachieveabalancedexpansionof domestic demand. if investment continuouslyoutpaces consumption, the productive capacitycreatedwill be underutilized,whichwill depressrevenuesand,totheextentthatinvestmentisdebtfinanced, itwill create problems in the domesticfinancialsystem.

Turning to the third component of domesticdemand(i.e.householdconsumptionexpenditure),thefinancialabilityofasizeablegroupofconsum-erstodelink,atleasttemporarily,consumptionfromcurrentincomewillfacilitateabroad-basedincreaseinconsumptionexpenditure.Suchadelinkingmightoccur,forexample,inanticipationofahigherfutureincomeorforreasonsofsocialinterdependenciesinconsumption.boththesefactorsmaywellbeconsid-eredkeycharacteristicsofmiddle-classhouseholds.Usually, low-incomehouseholdswillnothave thediscretionary income or the savings required toengage in spending unrelated to current income,eveniftaxpoliciesandgovernmenttransferstolow-incomehouseholdsaffectconsumptionspendingby

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thiscategory.High-incomehouseholdsarelikelytopreferspendingonconspicuous,luxurygoods,andtheirnumberwillgenerallybesmallerthanthatofmiddle-classhouseholds.Moreover,generally it ismiddle-classhouseholdsthatseekaccesstoconsumercreditwhichfinancespurchasesofdurableconsumergoods.Aninitialprovisionofthepurchasingpowerrequired for accelerated consumption expenditurethroughsourcesdelinkedfromwageincomewouldalsolimitanyadverseconsequencesforinternationalcompetitivenessthatcanbeduetoashiftfromanexport-oriented growth strategy,which has oftenreliedonlowwages,toagrowthstrategythatreliesmoreonprivateconsumption.However,tobesus-tainable,thiswilleventuallyrequireahigherwageincome.

The autonomous part ofmiddle-class con-sumptioncouldalsobefinancedbyborrowingfromabroad,whichwouldappearasanexternaldeficitin the national income accounting identity (equa-tion1),orthroughvariouspossibilitiesthatwouldreduceleakagebyincreasingthesizeofs(=1minusthemarginalpropensitytoconsumeoutofincome)inequation(2):areductionofspendingorsavingsby another class of households, for exampleby aredistributionofincome(throughtaxesortransfers)fromhigh-incometomiddle-classhouseholds,bor-rowing from domestic lenders, and/or improvedsocialsecuritysystems.

However, if agreater roleofhouseholdcon-sumption in a country’s growth strategy is to besustainableinthecurrentcontext,wherethegrowthof itsexports isconstrainedbyslowgrowth in itsdestinationmarkets,thebulkoftheriseinconsumerdemandmustbemetbydomesticproductionratherthanbyimports.Someofthisdomesticproductionmay consist of those goods thatwere formerlyexported to developed countries, but the restwillneed tocomefromincreaseddomesticproductionmadepossiblebyinducedinvestment.Thisinturn

will create employment and income for domesticconsumers and lead to an increase in consumptionlinkedtocurrentincome.Thusthecreationofdomesticpurchasing power through jobs and income is anessentialconditionforashiftfromanexport-orientedto amore domestic-consumption-oriented growthstrategytobesustainable,asitwillboostthenon-autonomouscomponentofhouseholdconsumption.

Thislatterpointillustratesthatevenagrowthstrategybasedonanincreaseindomesticdemandneedstogivestrongemphasistothesupplystruc-ture of the economy. induced investmentmaybeparticularlysensitivetotwofactors.First,thetastesandpreferencesofmiddle-classconsumersindevel-oping countriesmaywell differ from the existinghigh-endproductsmuchsoughtafterbyconsumersindevelopedcountriesandbythemostaffluentgroupsof consumers in the largest cities of developingcountries,whoarethestandardtargetsofdeveloped-countryfirms.itmaybeeasierfordomesticproducersthanforeignproducerstodevelopgoodswhosechar-acteristicsmatchthepreferencesoflocalmiddle-classconsumers. Second, emphasizing that trade is notcostless,andthatgeographicaldistancetomarketsstillmatters,theliteratureoninternationaltradeandeconomic geography has shownhowmarket sizeandrelativegeographicpositionaffectspecializationpatterns.inparticular,greaterdomesticdemandformanufacturedconsumergoods“willleadtohigherwageswhich, in the presence of non-homotheticpreferencescombinedwithpositivetradecosts,willshift local production towards themanufacturingsector”(breinlichandCuñat,2013:134).intakingadvantageoftheassociatedinnovationopportunities,developing-countryfirmswould need to combineinvestment in supply- and demand-dynamic sec-tors, therebyreducing the importcontentof risingdomestic consumption expenditure, i.e. increasingtheircountry’sε/πratio,asexpressedinequation(4),especially through a decline inπ associatedwithprivateconsumption.

Shifting Growth Strategies: Main Implications and Challenges 101

1 Treatingthecurrentaccountasexactlyequaltonetexportsisanapproximation,whichassumestransfersto equal zero.Transfers in the formofworkers’remittances play a significant role in the nationalincomeofpoorcountries.

2 Foradiscussionofotherdemand-orientedgrowthmodels,seeSetterfield,2010.

3 Thisrelationshipissubjecttoanumberofassump-tions,includingconstantrelativeprices(ortherealexchangerate),andtheMarshall-lernerconditionbeingjustsatisfied(i.e.thesumofthepriceelas-ticitiesofdemandfor importsandexportsequalsunity),sothatthegrowthofexportsissolelydeter-minedby thegrowthofworld income.Thirlwall(2013:87–90)concludesfromareviewofa“massofstudiesapplyingthemodelinitsvariousformsto individual countries and groups of countries”thatthe“vastmajorityofstudiessupportthebal-ance of payments constrainedgrowthhypothesisfortwobasicreasons.Thefirstisthatitisshownoverwhelminglythatrelativepricechangesorrealexchangeratechangesarenotanefficientbalanceofpaymentsadjustmentmechanismeitherbecausethedegreeoflong-runchangeissmall,orthepriceelasticity of exports and imports is low.…Thesecond reasonwhy themodelfits sowell is thatevenifbalanceofpaymentsequilibriumisallowed…thereisalimittothecurrentaccountdeficittoGDPratiothatcountriescansustain”.Forfurtherdiscussionofthedebateaboutthisrelationship,seeMcCombie(2011).ForafulldiscussionabouthowThirlwall’slawrelatestoKaldoriangrowththeory

andabouttherobustnessofitsbasichypothesistoextensionssuchastakingaccountofrelativepricedynamics,internationalfinancialflows,multi-sectorgrowth,cumulativecausation,andtheinteractionbetween theactualandpotential ratesofgrowth,seeSetterfield(2011).

4 ForanextensionofThirlwall’slawtoamulti-sectoraleconomy,seeAraujoandlima(2007)andRazmi(2011).

5 While inducedimportsmaybethemainfactor intheleakageidentifiedinequation(3),savingsandtaxationalsoplayarole.Savingscausehouseholds’expenditure to be lower than their total income.Households’ net acquisition of financial assetsandother formsofwealth reduces the amountofdisposable income that constitutes consumptionexpenditure.However,dependingontheagestruc-tureofthepopulationandtheavailabilityofsocialsecuritysystems,especiallyforseniorcitizens,thisreductionislikelytobesmallformostindividuals,especially thosebelonging tomiddle-classhouse-holds.Dataonthedistributionofhouseholdwealthindicateahighconcentration,withtheshareofthetop10percentofadultsholdingovertwothirdsofglobalwealth(Daviesetal.,2010).Moreover,accu-mulatedwealthisusuallyusedtofinancehousing,ratherthandurablegoodsconsumption.

6 Thecompositionofprivateconsumptionbetweentradablegoodsandnon-tradableservicesalsoplaysa role.Workers in the latter sector demandmoreimportsbutdonotcontributetoexports,withensuingadverseeffectsonthebalanceofpayments.

Notes

Trade and Development Report, 2013102

AraujoRAandlimaGT(2007).Astructuraleconomicdynamics approach to balance-of-payments-con-strainedgrowth.Cambridge Journal of Economics,31(5):755–774.

blanchardoandleighD(2013).Growthforecasterrorsand fiscalmultipliers.Working PaperNo 13/1,internationalMonetaryFund,Washington,DC.

breinlich H and CuñatA (2013). Geography, non-homotheticity,andindustrialization:Aquantitativeanalysis.Journal of Development Economics,103(July):133–153.

bussièreM,CallegariG,GhironiF,SestieriG,YamanoN (2011). estimating trade elasticities:Demandcompositionandthetradecollapseof2008–09.NbeRWorkingPaper17712,Cambridge,MA,December.

bussoloM, deHoyosRe,MedvedevD and van derMensbruggheD (2011).Global growth and dis-tribution:China, india, and the emergence of aglobalmiddleclass.Journal of Globalization and Development,2(2):Article3.

DaviesJb,SadströmS,ShorrocksAandWolffeN(2010).Thelevelofdistributionofglobalhouseholdwealth.The Economic Journal,121(1):223–254.

G20(2009).leadersStatement:ThePittsburghSummit.Athttp://www.g20.utoronto.ca/2009/2009communique0925.html.

HarrisonAandRodriguez-ClareA(2010).Trade,foreigninvestment, and industrial policy for developingcountries. in:RodrikD andRosenzweigM, eds.Handbook of Development Economics, Vol.5.North-Holland,Amsterdam:4039–4214.

KharasH (2010).Theemergingmiddleclass indevel-oping countries.WorkingPaperNo. 285,oeCDDevelopmentCentre,Paris.January.

MayerJ,butkeviciusA,KadriAandPizarroJ (2003).Dynamicproductsinworldexports.Review of World Economics,139(4):762–795.

McCombie JSl (1985).economic growth, theHarrodforeign trademultiplier and the Hicks’ super-multiplier.Applied Economics,17(1):55–72.

McCombie JSl (2011).Criticisms anddefencesof thebalance-of-payments constrained growthmodel,some old, some new.PSL (Paolo Sylos Labini) Quarterly Review,64(259):353–392.

RazmiA(2011).exploringtherobustnessofthebalanceofpayments-constrainedgrowthideainamultiplegoodframework.Cambridge Journal of Economics,35(3):545–567.

SetterfieldM(ed.)(2010).Handbook of Alternative Theories of Economic Growth.CheltenhamandNorthampton,MA,edwardelgar.

SetterfieldM(2011).TheremarkabledurabilityofThirl-wall’s law.PSL (Paolo Sylos Labini) Quarterly Review,64(259):393–427.

ThirlwallAP(1979).Thebalanceofpaymentsconstraintas an explanation of international growth ratedifferences.Banca Nazionale del Lavoro Quarterly Review,32(128):45–53.

ThirlwallAP(2002).Trade, the Balance of Payments and Exchange Rate Policy in Developing Countries.CheltenhamandNorthampton,MA,edwardelgar.

ThirlwallAP (2013).Economic Growth in an Open Developing Economy: The Role of Structure and Demand. Cheltenham and Northampton,MA,edwardelgar.

References

Financing the Real Economy 103

Aredesignofdevelopmentstrategiesinvolvesstructuralchangeaswellasanexpansionofproduc-tivecapacitiesandtheiradaptationtonewdemandpatterns,allofwhichrequirefinancing.Theavail-abilityandconditionsofsuchfinancinghaveevolvedsignificantlyoverthepastfewdecades.inaddition,therecenteconomicandfinancialcrisispresentsnewchallengesforthefinancialsectoranditscapacitytoprovidelong-termcreditforinvestment.Thischapteranalysesthechallengesandoptionscurrentlyavail-abletodevelopingandemergingmarketeconomies1tofinancetheirdevelopment.

investmentfinancingindevelopingcountries,especiallylow-incomecountries,hasbeenfrequentlylinked to foreign capital.The view that foreignfinancingisnecessaryandefficientisbasedontheneoclassicalassumptionthat,sincecapitalisscarceindevelopingcountriesandabundantindevelopedones, themarginal return on capital is higher indevelopingcountries, thusprovidingstrongincen-tivestoinvestmentinthelatter.Moreover,sincethelevelofincomeislowindevelopingcountries,andthemajorityofthepopulationconsumesmostofit,resultinginashortageofsavings,it isarguedthatwith open capital accounts, foreign capital couldfillthesavings-investmentgap.Theownersofthatcapitalwouldobtainahigherreturnindevelopingcountriesthanintheirhomecountry,whiletherateofinvestmentwouldriseintherecipienteconomy

withoutreducingthealreadylowlevelsofdomesticconsumptionthere.inadditiontothelong-termben-efitsofhigherinvestmentsincapital-pooreconomies,access to foreign capitalwould enable short-termsmoothing of the economic cycle. For instance, anegative external shock that reduces export earn-ings could be cushioned through a foreign loan,whichwouldbe reimbursedwhenexportearningsriseagain.Accesstoforeignfinancewouldthereforesupportdomesticexpenditureduringbadtimesandmoderateitduringbonanzas,producinganoverallcountercyclicaleffect.

However, empirical evidence has repeatedlyinvalidatedthesetheoreticalassumptions.Forsure,foreigncapitalinamountsthatcanbeproductivelyabsorbed by the domestic economymay be veryhelpful in acceleratingproductivitygrowth,diver-sification and industrializationwhen it is properlyoriented to investment in realproductivecapacity.but,asdiscussedinthischapter,unrestrictedcapitalinflowsgenerallyhavenotbeenaccompaniedbyasustainedincreaseofinvestmentinrealproductivecapacity;norhavetheyledtohigherandmoresta-bleGDPgrowthrates.First,notallcapitalinflowsareusedforthefinancingofproductiveinvestment.Foreignloansmaybechannelledthroughdomesticfinancialintermediariestowardsfinancialspeculationorimportsofconsumergoods.Theymayalsobeusedfor servicing foreigndebtor re-channelledabroad

Chapter III

FINANCING ThE REAL ECONOMy

A. Introduction

Trade and Development Report, 2013104

through an increase in external private financialassets(“capitalflight”).Andsecond,foreigncapitalinflowshaveoftenbeenprocyclical,accentuating(orevengenerating)thebusinesscycleintherecipientcountries. indeed, they have played a key role inall the“twincrises”(i.e.balance-of-paymentsanddomesticfinancialcrises)ofthelastthreedecadesinthedevelopingworld.

empirical studies conducted by economistsfrom fairly diverse theoretical schools of thoughthave failed tofind a positive correlation betweenopennesstointernationalcapitalflowsanddevelop-ment(bhagwati,1998).indeed,capitalflowshavenotonlybeenasourceofinstability;theyhavealsoprovedtobeeitherineffective,orevennegative,forlong-termgrowth(Prasadetal.,2003;Prasad,RajanandSubramanian,2007;Jeanne,SubramanianandWilliamson, 2012).This also explainswhy, sincethelate1990s,anincreasingnumberofdeveloping-country governments have becomemore cautiousaboutreceivingmassiveamountsofcapitalinflowswhichareoftentriggeredbyeventsoninternationalmarkets and bymonetary policies in developedcountries. Policies in developed countries thatmightgeneratesuchcapitalmovements,suchastherecenthugeinjectionsofliquidityaspartof“non-conventional”expansionarymonetarypolicies,arecriticizedfornottakingintoaccounttheirpossiblemacroeconomiceffectsondevelopingcountriesandfortheirpotentialtofuela“currencywar”.

Therecentglobalfinancialcrisisismorethanjust the latest episode in a long list of boom-bustcyclesoverthepastthreedecades;itisaneventthatshouldleadpolicymakerstocallintoquestion,evenmore seriously thanbefore, thegovernanceof theinternationalfinancial systemand to seekways toimprove it.This crisis, and the global imbalancesthathavecontributedtoit,haverevealedfundamentalflawsinthefunctioningoffinancialsystems,notonlyinthemajorfinancialcentresbutalsoatthegloballevel.Thecrisishasalsorevealedtheshortcomingsofmonetarypoliciesthatnarrowlyfocusonmonetarystability,understoodaslowconsumerpriceinflation.Thereisapressingneedformonetaryauthoritiestopaygreaterattentiontofinancialstabilityandtothestrengthening of the real economy, in addition to

monetarystability.Afterall,itistherealeconomythatdeterminesfinancialsoundnessandthecapac-ityofborrowerstopaybacktheirdebts.Fromthispointofview,thecriticalquestionisnothowmuchmoneyisgeneratedbythemonetaryauthoritiesorthecommercialbanks(asmonetaristtheorysuggests),butwhether thatmoney is used for productive orunproductivepurposes.

in aworld of acceleratedfinancial expansionandlargeinternationalcapitalmovements,developingcountriesfaceadualchallenge.ontheonehand,theyneedtohaveeffectivemechanismstoprotectthem-selvesagainstdestabilizingfinancialshockscausedbyhugecapitalinflowsandoutflows.ontheotherhand,theyneedtoensurethatthefinancialsystem–oratleastthelargestpartofit–fulfilsitsmainfunction,whichistoservetherealeconomybyfinancingpro-ductiveinvestmentandsupportingthedevelopmentoffirmsandtheeconomyasawhole.inorderfordomesticfinancialsystemstofulfilthesefunctions,theyhave tobeorganizedandmanaged in suchawaythattheyprovidesufficientandstablelong-termfinancingandchannelcreditflowstoproductiveuses.Thiswillprobablyrequirereduceddependenceonforeignshort-termcapitalandagreaterrelianceondomesticsourcesoffinance,whichareoftenmuchlargerthaniscommonlyassumed.Hence,amajorpolicyissueinthefinancialsphereis:howcandevel-oping countries advance their development goalsdespitethecrisisthatcontinuestoweakenfinancialandeconomicconditionsinthedevelopedworldandtheinternationalfinancialsystem?

Sectionbof thischapter takesa longer termperspectiveonthisissuebytracingtheevolutionofglobalfinancesincethe1970s,andconsideringhowthishasaffecteddevelopingandtransitioneconomies.SectionCthendiscussestheimpactsondevelopingcountriesofboththeglobalfinancialcrisisandthepoliciesfollowedinsystemicallyimportantfinancialcentres.Finally,sectionDdiscussesthelessonsthatcanbederivedfromtheseexperiencesandthepolicyoptionsthatareavailabletodevelopingandtransi-tioneconomiestoreducetheirmacroeconomicandfinancialvulnerabilityandensurethatthestructuralchangesneededinthenewglobalenvironmentcanbefinancedinasustainableway.

Financing the Real Economy 105

1. Trends in cross-border capital movementsandfinancialflows to developing countries

Since themid-1970s, foreigncapitalflows todeveloping countries have increased dramatically,but theyhavebeenveryvolatile.Theaccelerationoffinancial globalization, spurredby far-reachingliberalizationandderegulationoffinancialsystemsworldwide, led toa rapid increase incross-bordercapitalflows,whichjumpedfrom$0.5trillionin1980(equivalentto4percentofglobalGDPand25percentofthevalueofinternationaltrade)to$12tril-lionin2007(equivalentto21percentofglobalGDPand84percentofinternationaltrade)(chart3.1A).Muchofthesecapitalmovementstookplaceamongdevelopedcountries,whichaccountedfor80percentofthestockofforeign-ownedfinancialassetsby2007(lundetal.,2013).

However,therelativeimportanceofdevelop-ing countries as recipients of international capitalflowshas changed significantly over the past fewdecades.These countries saw an increase in suchinflowsbetween1976and1982andagainbetween1991 and1996, followed in both cases by abruptdecreases.Theirshareintotalcapitalinflowsreacheditshighest level soonafter theonsetof theglobalfinancialcrisis(26.4percentoftotalinflowsduringtheperiod2008–2011).This reflectednotonly anincreaseofflowstodevelopingcountries,butalsoasharpfallofflowstodevelopedcountries(table3.1andchart3.1b).

largeandvolatilecapitalmovementsremainachallengefordevelopingcountries,andthishasnotdiminishedwith the crisis. indeed, in 2010–2011

capitalflowsactuallyexceededtheirlevelsof2007inAfrica,latinAmericaandChina.Moreover,thestructuralfactorscontributingtotheirpre-crisissurgearestillinplace.Thereisstillconsiderablepotentialforinternationalinvestorsindevelopedcountriestodiversify their portfolios, particularly to emergingmarket economies, in searchofhigh returns.Thisisduetoagradualdiminishingofthe“homebias”ininvestmentportfolios,abiasthatmakesinvestorsholddomesticfinancialassetsinexcessoftheshareofsuchassetsinglobalmarketcapitalization(Haldane,2011).Giventhemagnitudeofglobalfinancialassets(estimatedat$225trillion,ormorethanthreetimestheworld’s gross product),2 evenminor portfolioadjustmentsorientedtowardsdevelopingcountrieswouldrepresentanincreaseinsuchflowsataratethatcoulddestabilizetheeconomiesofthesecountries.3

Anothermajorchangethathassurfacedinthelast fewdecades is related to thecompositionanduse of capital flows. in the decades immediatelyfollowingtheSecondWorldWar,foreignfinancingwasrelativelyscarceandconsistedmainlyofforeigndirectinvestment(FDi)orloansfromofficialsources,eitherbilateralormultilateral.bilateralfinancingwasmainlyintheformoftradecreditsprovideddirectlybypublicagenciesofdevelopedcountriesorinsuredbythem.Suchcreditsweredirectlylinkedtoimports,particularlyofcapitalgoods.MultilateralloansfromtheWorldbank and regional development bankswerealsoorientedtowardsspecificrealinvestmentprojects.loansfromtheinternationalMonetaryFund(iMF)wereofadifferentnature,sincetheysoughttocoverbalance-of-paymentsdeficitsarisingfrommacroeconomicdisequilibria.ontheborrowers’side,alargeshareoffinancingwenttothepublicsector(includingState-ownedfirms)ortoprivateentitiesintheformofpublicly-guaranteedloans.

b. global trends in finance and their impacts on developing and transition economies

Trade and Development Report, 2013106

Fromthemid-1970s,privatelendersincreasinglyreplacedofficiallendersasthemainsourcesofexter-nalfinancingfordevelopingcountries.internationalbanksrecycledpetrodollarsbyprovidingsyndicatedloansatvariableinterestratestodevelopingcoun-tries,particularlyinlatinAmerica.by1979–1981,such commercial bank loans accounted for some57percentofnetcapitalflowstoemergingecono-mies,whileofficiallending(bilateralloansorcreditfrominternationalfinancialinstitutions)declinedtobarelymorethan20percent(table3.2).

However,withthelatinAmericandebtcrisisin1982anda“suddenstop”ofbankcreditintheregion,officialfinancingagainhadtofillpartofthegap.itwasusedforservicingdebttoprivatecreditors(inaschemetermed“revolvingdoor”)inordertopreventanoutrightdebtdefault.butthisincreaseinofficiallending did not last long.As international banksmanaged to recapitalize and build up provisions,andwerethereforeinasufficientlystrongpositiontobeabletooffloadtheirloansthathadbeendeeplydiscounted in secondarymarkets, theyengaged ina debt restructuring process supported by the so-called“bradyPlan”.Underthisplan,implemented

in several highly indebted countries in the regioninthelate1980sandearly1990s,bankloansweretransformed into long-term securities,whichwerethenpartlysoldbytheoriginalbankcreditorstoavarietyoffinancial investors.Thiswaspartof thelargertrendof“securitization”,whichwasaccom-paniedbyachangeinthestructureofcreditors inwhichother(non-bank)privatesourcesbecameanimportantsourceoffinanceforemergingeconomies(table3.2).

Anothermajor change in the composition ofexternalfinancialflowstodevelopingcountriessincethe1990shasbeentherapidriseinFDi,whichgrewfromaround15percentofnetinflowsduringtheperi-od1976–1982tomorethan50percentinthe2000s.Thiswasa fairlygeneral trendamongdevelopingcountriesasawhole,includingbothmiddle-incomeandleastdevelopedcountries(lDCs).

During the 1980s, external financing fromofficialsourcestomiddle-incomecountriesdeclinedfurther, and recovered only for short periods inresponse to the variousfinancial crises (in 1982–1986,1998and2009).bycontrast,externalfinancing

Chart 3.1

NET CAPITAL INFLOwS by ECONOMIC GROUP, 1976–2011

Source: UNCTAD secretariat calculations, based on IMF, Balance of Payments Statistics database.Note: Net capital inflows by economic group correspond to net FDI, portfolio and "other investment" inflows.

0

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1976 1981 1986 1991 1996 2001 2006 2011

A. In billions of current dollars

Developed economies Transition economiesDeveloping economies

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1976 1981 1986 1991 1996 2001 2006 2011

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Financing the Real Economy 107

in the form of bilateral andmultilateral loansremainedimportantforlDCsuntilthemid-1990s,when,with thestartof theHeavily indebtedPoorCountries(HiPC)initiativein1996,grantsincreas-ingly replaced concessional loans.Consequently,theircapitalaccountbalance(whichincludesgrants)increasedsignificantly,fromanaverageof0.4percentof theGDPoflDCscountriesfor theperiod

1987–1996to1.9percentonaveragefor1997–2011.4Thelowshareofprivatecapitalinthecompositionof capital inflows inlDCs reflects the historicalreluctanceofprivatecapitaltoundertakewhattheyconsideredtoberiskyinvestmentsinlDCs.iteffec-tivelyshieldedlDCsfromthewavesofcapitalflowsthataffectedandoftendestabilizedotherdevelopingandtransitioneconomiesoverthelasttwodecades.

Table 3.1

NET CAPITAL INFLOwS by ECONOMIC GROUP AND REGION, 1976–2011

1976–1982

1983–1990

1991–1996

1997–2000

2001–2007

2008–2011

Cumulative total

In $ billion (annual average) ($ billion)

Developed economies 289 652 1084 2930 5543 3459 78 094Transition economies … … 12 22 99 146 1 436Developing economies 71 54 218 239 586 1291 12 462of which:

Africa 12 9 17 27 30 100 978Asia 22 33 123 109 449 912 8 386Latin America and the Caribbean 37 12 78 102 107 277 3 087

Memo item:LDCs 4 6 6 6 8 27 297World 360 706 1314 3190 6227 4896 91 992

As a percentage of total

Developed economies 80.2 92.3 82.5 91.8 89.0 70.7 84.9Transition economies … … 0.9 0.7 1.6 3.0 1.6Developing economies 19.8 7.7 16.6 7.5 9.4 26.4 13.5of which:

Africa 3.4 1.3 1.3 0.8 0.5 2.0 1.1Asia 6.1 4.7 9.4 3.4 7.2 18.6 9.1Latin America and the Caribbean 10.3 1.7 5.9 3.2 1.7 5.7 3.4

Memo item:LDCs 1.2 0.8 0.4 0.2 0.1 0.6 0.3Total 100 100 100 100 100 100 100

As a percentage of GDP

Developed economies 4.1 5.0 5.0 12.1 16.8 8.4 8.3Transition economies … … 6.3 4.9 8.4 6.6 6.8Developing economies 4.0 2.0 4.7 3.9 5.7 6.8 4.3of which:

Africa 4.3 2.2 3.8 5.4 3.3 6.3 3.9Asia 2.8 2.2 4.7 3.0 6.7 7.3 4.3Latin America and the Caribbean 5.3 1.5 4.8 4.9 3.9 5.8 4.1

Memo item:LDCs 5.3 4.5 4.2 3.7 3.1 5.2 4.3World 4.1 4.5 4.9 10.4 14.2 7.8 7.4

Source: UNCTAD secretariat calculations, based on IMF, Balance of Payments Statistics database.

Trade and Development Report, 2013108

lDCs’lackofaccesstoprivatecapitalwasalsodueto thestringent limitsonprivateborrowingsetbythebrettonWoodsinstitutionsinorderforthemtocontinue to access concessional borrowing in thecontext of debt reduction programmes.Countrieswithmoreseveredebtproblemsremaindependentonhighlevelsofconcessionalfinancingtomaintaindebtsustainability(iMF,2010).5

in themiddle-income countries, the generalshifttoprivatesourcesoffinanceoccurredinparal-lelwithachangeinrecipientswithineachcountryandintheiruseoffinancing.Sincethemid-1970s,foreignfinancinghasbeendirectedincreasinglytoprivatebanksandfirms,muchofitassociatedwithpurelyfinancialmovements, suchas“carry trade”operationsandfinancialspeculationintherecipientcountry, eventually leading to large capital out-flows.Concomitantly, therehasbeen lessexternalfinancingdirectedat importsof capitalgoodsandproductiveinputs.Thisimpliesthatitwasoftenthedecisionoflenders(internationalinvestors)toinvestindevelopingcountriesratherthanthedecisionofborrowerstoseekloans,butthereceivingcountriesinitiallywelcomed such inflows as a signof theircreditworthinessandasrecognitionoftheireconomicperformanceandpotential.However,theincreasing“privatization”ofcapitalflows,andthefactthattheyfrequently represented purelyfinancial operationsrather than transactions related to real investment,contributedtotheirgreaterinstability,astheybecamepronetosuddenstopsandreversals.Giventhevery

largeamountsoffundsinvolvedrelativetothesizeof the recipient developing economies, financialglobalization became amajor destabilizing factorformanyofthem.

2. Capitalflows,boomsandbustsinemerging market economies

external financial flows to developing andtransitioneconomieshaverepeatedlyprovedtobeadouble-edgedsword.ontheonehand,theyhaveoftenbeenawayofalleviatingbalance-of-paymentsconstraintsongrowthandinvestment.ontheotherhand, the large size offinancial inflows and theirinstability have often led to an overvaluation ofcurrencies, lending booms and busts, asset pricebubbles, inflationarypressuresandthebuild-upofforeignobligationswithoutnecessarilycontributingeithertogrowthortoimprovingacountry’scapac-itytoservicethoseobligations.Andthedryinguporreversalofsuchinflowshasfrequentlyresultedinpressuresonthebalanceofpaymentsandonthefinancingofboththeprivateandpublicsectors.Themagnitudesinvolvedintheseswingscanbelargevis-à-visthesizeoftheassetmarketsofthedevelopingcountriesconcernedandalsorelativetothesizeoftheireconomies.Relianceonprivatecapitalinflowshasthereforetendedtoincreasemacroeconomicandfinancial instability thathashampered, rather thansupported,long-termgrowth.

Theexperienceofpastepisodesofstrongnetcapital inflows6 followed by sharp slowdowns orreversals offers important lessons for the presentsituation.Therewerethreemajorwavesofcapitalinflows to emergingmarket economies prior tothemost recent financial crisis: in 1977–1981,1990–1996 and 2002–2007 (chart 3.2).All theseepisodes presented some common features. First,theyallstartedwhentherewasabundantliquidityinthedevelopedcountriesresultingfromtheirpursuitofexpansionarymonetarypolicies,and/ortheirlargebalance-of-payments deficitswhichwerefinancedby the issuanceofdebt in internationalcurrencies(mainly in dollars).At the same time, developedcountriesexperiencedsignificantslowdownsrelatedtodifferentshocks:theoilshockinthesecondhalfofthe1970s,theSavingsandloancrisisintheUnitedStates, the crisis of theeuropeanexchangeRate

Table 3.2

COMPOSITION OF ExTERNAL FINANCING TO EMERGING MARkET ECONOMIES, 1979–2012

(Annual average, per cent)

1979–1981

1982–1990

1991–2000

2001–2007

2008–2012

Official flows 21.0 42.9 15.8 -1.0 9.1FDI 9.9 25.1 40.0 57.5 41.1Portfolio equity investment 3.2 4.1 9.3 3.7 -0.9Commercial banks 56.8 9.5 10.2 19.0 13.5Other private creditors 9.2 18.5 24.7 20.9 37.2

Total 100 100 100 100 100

Source: UNCTAD secretariat calculations, based on Institute of International Finance, Capital Flows database.

Note: Numbers do not add to 100 due to rounding.

Financing the Real Economy 109

Mechanism(eRM)andthefinancialcrisisinJapanintheearly1990s,andtheburstingofthedot-combubble in theearly2000s.onall theseoccasions,themonetaryauthoritiesinthedevelopedcountrieslowered their policy interest rates to support theireconomiesandfinancialsystems.Giventhesedevel-opments,developingcountriesappearedtopresentattractivealternativesforinternationalinvestors,astheireconomiesweregrowingfasterthanthoseintheNorthandwereprovidingopportunitiesforhigherreturns(Akyüz,2012).

Second, the reduction or reversal of capitalinflows in emergingmarket economies in the late1970s,mid-1990sandmid-2000sfollowedincreasesin policy interest rates in developed countries.Althoughexpansionarymonetarypoliciesindevel-opedcountrieswereamajorfactorcontributingtothosecapitalmovements,thesepoliciesalonewerenotenoughtogeneratestrongoutflowstodevelop-ingcountries;forinstance,thereductionofinterestratesindevelopedcountriesbetween1984and1986didnotgeneratelargeoutflowstoemergingmarketeconomiesbecausebanksneededtorecapitalizeandcreateadequateprovisionsduetotheirriskylatin

American assets resulting from the debt crisis inthatregion.

Third, how the capital inflowswere used byrecipientcountrieshasbeenanimportantadditionalfactordeterminingtheirimpactonthesecountries.When a large proportion of the inflowswas usedto finance a higher oil-import bill or investmentprojectswhich required imports of capital goods,theyhelpedtostabilizethedomesticeconomyandsupport growth. in other cases, however,wherecapitalinflowsweredirectedmainlytoprivatebanksforfinancingconsumptionor speculativefinancialinvestments,ortofirmsforfinancingcurrentexpendi-ture,theyhad(oftenstrong)destabilizingeffects.ifcapital inflowsarenotusedprimarily for imports,theycanleadtoastrongrealappreciationofthelocalcurrencyandseverelyharmdomesticindustries.insome countries,where currency appreciationwasthecornerstoneofanti-inflationarypolicies,capitalinflowsweremainlychannelledtotheprivatesectorthroughderegulatedfinancialsystems.Thisgener-atedanuncontrolledexpansionofdomesticcredit,whichledtofinancialfragilityassociatedwithrealestateandfinancialbubbles,currencyappreciation

Chart 3.2

neT pRivATe CApiTAl inFlows To eMeRging MARkeT eConoMies, 1978–2012

Source: UNCTAD secretariat calculations, based on Institute of International Finance, Capital Flows database; and UNCTADstat.Note: Data for 2012 are estimates.

0

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andsignificantcurrentaccountdeficits,eventuallyresultinginacrash.

Thelastmajorwaveofcapitalinflowstoemerg-ingmarketeconomieswasbuildingupwhentheseeconomiesprogressivelysurmountedtheeffectsofthefinancialcrisesofthelate1990sanddevelopedeconomies turned once again to an expansionarymonetary stance.Capital inflowsfirst poured intoeastandSouth-eastAsiaandthetransitionecono-miesofCentralandeasterneurope,whichresumedrapidgrowthratesin2000–2002,whileGDPgrowthinAfrica,latinAmericaandWestAsiaacceleratedlater,in2003–2004.between2005and2007,inflowsofprivatecapitaltoalldevelopingregionsreachedunprecedented levels: in 2007, those inflows intoemergingmarketeconomiesamountedto8percentoftheirGDPandtotalcapitalinflowstodevelopingcountriesexceeded10percentoftheirGDP.Duringthis period, about 80 per cent of such inflows todevelopingcountrieswenttoAsia,whichwasalsotheregionwhereprivatecapitalinflowsaccountedforthelargestproportionofGDP(morethan10percentonaverageduring thatperiodcomparedwith4.9per cent inlatinAmerica and4.2per cent inAfrica).Thetransitioneconomiesalsoreceivedverylargeamountsofforeigncapitalduringthatperiod(12.4percentofGDP).7

Thislastmajorwaveofcapitalinflowscametoahaltin2008and2009.Thiswasatypical,becausethereversaldidnotoccurinresponsetoanincreaseininterestratesinthemajordevelopedcountries;onthecontrary,thosecountrieshadloweredinterestratesineffortstomitigatethecrisis.Rather,whatislikelytohavecausedthereversalthistimewasthatthecrisis

inthemostadvancedfinancialmarketswasstillfreshin themindsof investors,making themextremelyriskaverseandeagertominimizetheoverallriskoftheirportfolios.However,thisprovedshort-lived,ascapitalflowstoemergingmarketssurgedoncemorein2010and2011.Againthiswasatypical,because“suddenstops”areusually followedbyprolongedreversals of capital inflows into emergingmarketeconomies.ThisconfirmsthefindingbyShin(2011),thatthecycleoffinancialflowsisdominatedbytheleveragecycleofbigbanks,whichinturnisassoci-atedwiththeirperceptionsofrisk.

Anotherdifferencerelatingtotherecentwavesofcapitalinflowssince2004isthattheirmaincoun-terpartinemergingmarketeconomieswasnotlargecurrentaccountdeficits,butrathertheaccumulationof foreign assets (i.e. capital outflows from theseeconomies), including international reserves.Thislargelyexplainswhythesuddenstopin2008–2009did not lead to severe economic crises in thesecountries.Themain exceptions to this rulewerethe emergingmarket economies ineurope,whichsawhugecurrentaccountdeficitsandexperiencedasevereeconomicsetbackduetoareversalofforeigncapitalinflows.

Themost recent experience shows that largecapitalinflowsfollowedbya“suddenstop”donotnecessarilytriggeranimmediatefinancialcollapseasinprevious“waves”ofcapitalflows.Thisraisesthequestionastowhetherthefinancialvulnerabilityofemergingeconomieshaschanged,andifso,why.Whatarethechallengestheynowfaceandhowcantheybeovercome?Thesequestionsareaddressedinthenexttwosections.

Financing the Real Economy 111

1. Thefinancialsituationandmonetarypolicies in developed countries

(a) Impacts of the crisis and policy responses

in order to understand the challenges fordeveloping countries, especially emergingmarketeconomies thatarepotentialdestinationsofanewwave of capital flows, it isworth recalling someimportantfeaturesofthelatestcrisisandthepolicyresponseofdevelopedcountries.

Therecentfinancialcrisisresultedfromasurgeof private indebtedness in developed countries.Awidespreadviewfiveyearsaftertheoutbreakofthecrisisisthatexcessivepublicdebtwasthecause,andthatitisalsothemainobstacletorecovery.However,itwastheprivatesectordebtthatincreasedrapidlyfrom themid-1990s onwards,while public sectordebt,forthemostpart,remainedflatorevendeclined(chart3.3).itisonlysince2008,followingtheonsetoftheglobaleconomiccrisis,thatpublicsectordebtbegantoriseasaresultoflarge-scalegovernmentbailoutpackages,theeffectofautomaticstabilizersand additional fiscal policymeasures to stabilizeaggregatedemand.Notwithstandingthisrise,privatedebtisstillamultipleofpublicdebt.itissurprisingthatneithertheeconomicauthorities,northecreditratingagenciesorthemanagersoffinancialinstitu-tions, seemed to be aware of themounting riskscausedbysucharapidincreaseinprivatedebt.Allofthemappeartohavehadextreme,butunjustified,confidence in the efficiency of financialmarketsand in theabilityofprivatesectordebtors (unlikethepublicsector)tohonourtheirdebtobligations.8

once thefinancial crisis broke out, followedbythebroadereconomiccrisis,therewasamarked

change in the financial behaviour of all actors –households, financial and non-financial firms andgovernments – in themajor developed countries.Following years ofmounting prosperity, duringwhichfinancialmarketshadfuelledthebuild-upofassetpricebubbles,householdsandfirmssuddenlysawadramaticdeteriorationoftheirbalancesheets.Theyfounditmoreandmoredifficult,ifnotimpos-sible,torevolvetheirdebts,letaloneincreasetheirborrowing,asthepricesoftheircollateralplunged.ontheothersideoftheledger,banksfoundthem-selvesburdenedwithpoor-qualityornon-performingloansandsecuritiesofdubiousvalue.Thesuddendisruptionofcreditflowsforcedaprocessofdelever-agingintheprivatesectorthatledtoasharpdownturnof economic activity.The contractionary effect ofthe crisis on economic activity in the developedeconomies could be contained only by increasingdebt-financed public spending by governments,whichactedasborrowers,investorsandconsumersoflastresort.Theseabruptchangesarereflectedinthenetlendingorborrowingpositionsoftheprivateandpublicsectors(chart3.4).

Whenthecrisiserupted,governmentsindevel-opedcountriesreactedwithstrongmonetaryandfiscalmeasures. Public spending rose quite significantly,whilecentralbanksprovidedemergencyliquiditytothefinancialsysteminordertocompensateforthesharpfallininterbanklendingandreducedinterestrates.Whentheworstofthecrisisseemedtobeover,andmanygovernmentsandinternationalinstitutions(wrongly)believedthatthemajorhindrancetoasus-tainedrecoverywasnotthelackofglobaldemandbuttheriseinpublicdebt,thismultiprongedsupportiveapproachcametoanend.Theviewthattheir“fiscalspace”wasexhausted led toa shift towardsfiscalausterity, andmonetarypolicy appeared to be thesoleavailableinstrumentofsupport.

C. The global crisis and the challenges ahead

Trade and Development Report, 2013112

Chart 3.3

PRIVATE SECTOR AND GROSS PUbLIC DEbT, SELECTED DEVELOPED COUNTRIES, 1995–2012

(Per cent of GDP)

Source: UNCTAD secretariat calculations, based on OECD.StatExtracts database.Note: Data for the United States on “gross public debt” refer to “debt of central government”. Data on “gross public debt” for 2012

are projections.

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Financing the Real Economy 113

Asinterestrateswerealreadyatorapproach-ing the lowestpossible limits, centralbanks inallthemajor developed economies turned increas-ingly to“unconventional”policies,which led toarapidexpansionoftheirmonetarybase.Moreover,inadditiontorescuingprivatefinancialinstitutionsintrouble,theysoughttorevivecreditanddemand,andalsotoreducetheperceivedriskoffinancialassets.Mostimportantly,thecentralbanksagreedtobuy(ortofinancetheacquisitionof)theirowngovernments’sovereignbonds.Thisexpandedtheirroleoflenderoflastresortandalsoblurredtheboundariesbetweenfiscalandmonetarypolicies.Theireffortsresultedinaballooningoftheirbalancesheets.Forinstance,betweentheonsetofthesubprimemortgagecrisisinAugust2007andtheendof2012,thebalancesheetofthebankofenglandgrewby380percent,andthoseoftheeuropeanCentralbank(eCb)andtheUnitedStatesFederalReserveSystemgrewby241percentand221percentrespectively.

Thecentralbanksuseddifferent instruments,dependingonthestructureandneedsoftheirecono-mies.Thisisreflectedinthedifferentcompositions

and profiles of their balance sheets. The eCb,giventhemorebank-centricnatureoftheeuro-areaeconomy, supplied liquidity directly to the bank-ingsector,mainlythroughalong-termrefinancingoperation (lTRo) (chart 3.5A).9 in addition, itimplementedbondpurchaseprogrammes,includinganewoutrightMonetaryTransactionsprogramme.TheUnitedStatesFederalReserve,bycontrast,sup-pliedliquiditythroughsecuritypurchases,notonlyTreasurysecurities,asithadtraditionallydone,butalsoprivatemortgage-backedsecurities(chart3.5b).Theselarge-scaleassetpurchasesaimedtostopthedeclineofassetprices,reviveconsumerspendingandsupporteconomicgrowth.Asimilarapproachwasfollowedbythebankofenglandand,morerecently,bythebankofJapan.

Theirstrategieshavebeenpartiallysuccessful.inparticular,thecommitmentbytheeCbtobuy(inthesecondarymarket)unlimitedquantitiesofsover-eignbondsofeuro-zoneperipherycountries(Greece,ireland,italy,PortugalandSpain)ledtoareductionoftheirsovereignriskpremiums.However,neitherineurope nor in theUnited States has the large

Chart 3.4

NET LENDING/bORROwING by SECTOR, UNITED STATES AND EURO AREA, 2000–2012(Per cent of GDP)

Source: UNCTAD secretariat calculations, based on United States, Bureau of Economic Analysis; and European Central Bank, Statistical Data Warehouse.

Note: Net lending positions are indicated by positive values, net borrowing by negative values.

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Trade and Development Report, 2013114

injectionof“high-poweredmoney”translatedintoincreasedbanklendingtotheprivatesector;onthecontrary,outstandingcredittotheprivatesectorhasactuallydeclinedasapercentageofGDP(chart3.6).The question iswhether the failure of banks toincreaselendingisduetotheirreluctancetolendortheunwillingnessofcompaniesandhouseholdstoborrow.Whatisclearisthatthecreditcrunchisnotdue tobanks lacking liquidityoraccess tocentralbankrefinancing.

euro-zonebanksappeartohavebeenusingtheadditionalliquiditycreatedbytheeCbasameansofrefinancingthemselvesorforaccumulatingdepositsat theeCb itself: commercial bankdepositswiththeeCbincreasedtothehistoricallyhighlevelof€800billionduring2012.Atthesametime,eCbsur-veysofsmallandmedium-sizedenterprises(SMes)intheeurozoneshowthatlendingactivityisstillverylow,notonlybecauseofweakdemandforcreditbutalsobecausefirmsarefindingitdifficult toobtainloans.Thisisseenasevidencethatcreditmarketsintheeuro-arearemainhighlydysfunctional.

economichistoryprovidesevidencethatcreditisslowtorecoverafteramajorfinancialcrisis,andthis timeisnodifferent.Privateactorsintheeurozone, Japan and theUnitedStates are increasingtheirsavings,hoardingcashorpayingdowndebt,andthereforetheirdemandforcreditislargelylim-itedtorefinancingloansthatarereachingmaturity.Manyofthemthatarewillingtoborrowmoreareexperiencing difficulty in accessing credit due touncertainty about their future income stream andthevalueoftheircollateral.inaddition,manybanksneedtoberecapitalizedowingtoadeteriorationoftheirloanportfolios,whichisfurtherlimitingtheircreditsupply.

The failure ofmonetary expansion to boostprivateexpenditure isa reminderof the“liquiditytrap”analysedbyKeynes(1936/1973),whichoccurswheneconomicagentsprefertokeepcashholdingsrather than investing funds in areas that present ahighriskofcapitalloss.Anecdotalevidencesuggeststhat thismaybehappening to someextent: liquidreserves held by industry and the banking system

Chart 3.5

ASSET COMPOSITION OF ThE EUROPEAN CENTRAL bANk AND ThE UNITED STATES FEDERAL RESERVE, 2003–2013

Source: UNCTAD secretariat calculations, based on United States Federal Reserve, Factors Affecting Reserve Balances (H.4.1) database; and European Central Bank, Statistical Data Warehouse.

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Financing the Real Economy 115

in theUnitedStates at the endof2012amountedtomore than$3 trillion, four timesashighas thestimuluspackageof$831billionprovidedunderthe2009AmericanRecoveryandReinvestmentAct.onerecentstudyarguesthatalmosthalfofthisamountwasin“excess”ofreasonableprecautionaryrequire-ments,estimatingthatifithadbeenredirectedintoproductiveinvestmentsitwouldhavehelpedcreatemillionsofjobsandlowertheunemploymentratetobelow5percent(Pollinetal.,2011).

othermajor economies have similar stock-piles,suggestingthatthe“precautionarymotive”forholdingliquidassetsisunderminingpolicymakers’attemptstousecheapcapitalasameansofinjectinglifeintoanervousanddemand-deficienteconomy.inJapan,forexample,recentestimatesputcompanies’liquidassetsataround$2.8trillion,up75percentsince2007.Similarly,intheeurozone,householdscurrentlyholdsome€7,000billionincurrencyanddeposits,andnon-financialcompaniesholdaround€2,031billion.10

Thiscoexistenceofidleliquidityheldbyagroupofeconomicagentsandliquidityshortagesfacedby

othersisnewevidenceofthe“brokentransmissionmechanism”onthemonetaryandfinancialmarkets.itsuggeststhatpolicyresponsesshouldincludebettertargetingoftherecipientsofmoneycreation.inotherwords,monetaryauthoritiesshouldfindameansofmakingcreditavailabletoagentsthatreallyneeditforusinginaproductiveway.

(b) Impact on capital flows

The previous subsection has described typi-calconditions thatareconducive to strongcapitaloutflows from developed countries. indeed, theyarelikelytobeevenmoreconducivetoasurgeinoutflows than those at the beginning of previous“waves”.Thisisbecausethereisalargeinterestratedifferentialinfavourofdevelopingcountries,ahugeamountofliquidityinthebankingsystemandlowdemandforcreditindevelopedcountries.Althoughimmediatelyfollowingtheonsetofthefinancialcrisistherewasasharpincreaseinpublicsectorborrowing,thesubsequentpolicyswitchtofiscalausterityandpublicdebtreductioniscausingdemandforpubliccredittofallaswell.buttheseconditionshavenot

Chart 3.6

MONETARy bASE AND bANk CLAIMS ON ThE PRIVATE SECTOR, 2001–2012(Per cent of GDP)

Source: UNCTAD secretariat calculations, based on IMF, International Financial Statistics and World Economic Outlook databases.Note: Monetary base for euro area corresponds to currency issued and central bank’s liabilities to depository corporations.

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inducedstrongandsustainedcapitaloutflowsfromdevelopedcountries;rathersuchoutflowshavebeenveryvolatile.

Capital outflows from theUnitedStates fellsignificantly immediately after the crisis erupted,andtherewasevenanincreaseininflowsin2008,testifyingtothecontinuedperceptionofthiscountryasa“safeportinastorm”eventhoughthestormhadoriginated there.outflows from theUnitedStatesrecoveredpartiallyinthesubsequentyears,butdis-playedmarkedvolatility,andremainedlowerthantheirpre-crisislevels(chart3.7A).Thisshowsthattheabove-mentionedfactorsarenotsufficientcondi-tionstoinducesuchoutflows;otherfactors,suchasageneralclimateofuncertainty,canalsohaveamajorimpactonthesizeofcapitalflows(Shin,2011),asdiscussedbelow.

CapitalflowsinandoutofJapan,unlikethoseof theUnitedStates, recovered swiftlyafter somecontractionintheyearsimmediatelyfollowingtheonsetofthecrisis,andevensurpassedpre-crisisflows,accountingforbetween10and15percentofGDPin2010–2011.Portfoliooutflowsin2011remainedrelatively high, as investors and speculators tookadvantageof close-to-zero interest rates toborrowinyen and invest abroad.This recoveryof capitaloutflowsfromJapanwaspartlybolsteredbyitssup-portiveregionalenvironmentofeastandSouth-eastAsia,whichcontrastssharplywiththatofeurope.

ineuropetherewasasimultaneouscontractionofbothinflowsandoutflowsofcapital(chart3.7b).by2011,capitalflowswereequivalenttolessthan20percentofGDP,comparedwithover30percentduringtheperiod2005–2007.Andsomecomponentsofthoseflowsdeclinedsharply.Forexample,euro-zoneportfoliooutflowsfellfrom$1,386billionin2005tojust$288billionin2010,andeventurnednegative in2011.Thecontractionofcapitalflowsto and fromeuropean countries reflects the sud-denstop in intraregionalcreditmovementsdue tothecrisis.Priortothecrisis,easyavailabilityofallkindsofcross-borderfinancinghadfuelledmountingimbalanceswithintheeU,whichhavebeenamajorcauseofitspresentproblems.Alsoofrelevancehasbeenthe“balancesheetrecession”thathasdeterredbanksfromlendingbothdomesticallyandabroad,andwhichhasbeendeeperandlongerineuropethaninotherdevelopedeconomieswherebanks’recapi-talizationhasprogressedmorerapidly(Koo,2011).

Capitalmovementswithineurope reproducemuchof the “centre-periphery”pattern thatmanydeveloping countries have endured in the past. inthelead-uptothecrisis,integratedfinancialmarketsallowed commercial banks in the coreeuropeancountries(France,GermanyandtheUnitedKingdom)tobuilduplargecross-borderexposuresintheeurozone’s“periphery”countries.Duringthesubsequentyears,however,europeanbankssignificantlyscaledback their exposures to their counterparts in theperiphery(chart3.8).Facedwithmarketvolatilityanduncertainty,banksinthecoreeuropeancountriesbegantoreducetheirclaimsontheperipherycoun-triesin2008.Thiscontinuedtofollowadownwardtrend,accountingforareductionof51percentfromthefirstquarterof2008tothefourthquarterof2012anditislikelytobemuchgreaterifotherperipherycountriesareincluded.11ThestockofGermanbanks’claimsonperipheraleuropefellbyroughly50percentfromtheirpre-crisispeakuntiltheendof2012,fromunder€600billionto€300billion(biS,2013).Atthelevelofindividualeuropeanbanks,outstand-ingloanstoperipherybanksdeclinedby30–40percent. For example,HSbC reduced its holdings ineuro-zoneperipherybanksby39.5percentinjustfourmonths, andlloyds reduced themby28percentoverthesameperiod(GoffandJenkins,2011).

Thepatternofcapitaloutflowsdifferedamongdevelopedcountries,whichmaybeduetothediffer-entrecipientsoftheseoutflows.Thestrongdeclineincapitalflowsintoandoutofeuro-zonecountrieswasmainlyduetointraregionaldevelopments.Japanesecapitaloutflows,ontheotherhand,werenotstronglyaffectedbythefinancialcrisis,probablybecausetheytargetedmainly emergingmarket economies anddevelopingcountriesinAsiathatwerenotasseverelyimpactedbythecrisis.AsfortheUnitedStates,asamajorfinancialcentre,ithasstronglinkswithbothother developed economies and emergingmarketeconomies.However,themajorgeneratorsofcapitalmovementsare largebankswhosemainoffices invariouscountrieshandlecapitalmovementsbasedontheirinterests,andtheygenerategrossoutflowstowards third countries thatmay have originatedfromseveraldifferentcountries.Consequently,thereisnotnecessarilyadirectlinkbetweenthemacro-economicandmonetaryconditionsprevailinginaspecificcountryandthevalueofitscapitalinflowsandoutflows.Thoseconditionsmaypromoteorhin-dertheincentivesforinternationalbankstoincreasetheirinternationalcapitalflows,whichmaythereforeoriginatefromtheirbranchesindifferentcountries.

Financing the Real Economy 117

Chart 3.7

NET CAPITAL INFLOwS AND OUTFLOwS, 2005–2012(Billions of current dollars)

Source: UNCTAD secretariat calculations, based on IMF, Balance of Payments Statistics database.Note: Data were available for only 67 developing countries (excluding LDCs) and for 28 LDCs.

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FDI: acquisition of financial assetsFDI: incurrence of liabilities

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Trade and Development Report, 2013118

2. Impacts and policy responses in developing economies

Thehistoricalexperiencediscussedinsectionbshows that several factors have played a role indeterminingcapitalmovementsfromdevelopedtodevelopingcountries.Atleastuntiltheglobalcrisis,allthewavesofstrongcapitalflowsfromdevelopedtodevelopingcountrieswerestartedby“pushfac-tors”relatedtoconditionsindevelopedcountries.butinadditiontherearealso“pullfactors”relatingtothedemandforforeigncapitalindevelopingcountriesthatinfluencethesizeanddirectionofcapitalflowstoandfromthesecountries.

box3.1presentstheresultsofaneconometricexercise that analysed the determinants of capitalflows receivedby19 emergingmarket economiesbetween 1996 and 2012.The disparities inGDPgrowthratesandinreturnsonfinancialinvestmentsappear to be significant explanatory variables.

Thefirst indicates that fasterGDPgrowthrates inemergingmarketeconomiesthanintheG-7groupof developed countries had a positive impact oncapital flows from the developed to the emergingmarketeconomies;thesecondestimatesthepositiveimpactofinterestratedifferentialsbetweenemergingmarketeconomiesandtheUnitedStates,adjustedforgainsorlossesfromexchangeratechanges.Asthesevariablescombineindicatorsfrombothsourceandreceivingcountries,theymaybeseenasboth“pull”and “push” factors.Risk perception in developedcountrieswasthemainpurely“pushfactor”identi-fiedinthisexercise,andshowsanegativesign.Thismeansthatarisingperceptionofriskindevelopedcountriesdiscouragedcapitaloutflowstoemergingmarket economies. Symmetrically, stockmarketindices in emergingmarket economies reflectedinvestorsentimentinthereceivingeconomies,hencerepresentinga“pullfactor”.

Allthesefactorsappeartohavehadasignificantimpactoncapitalflows.However,differentfactors

Chart 3.8

EUROPEAN UNION: CORE COUNTRIES’ COMMERCIAL bANk ExPOSURE TO PERIPhERy COUNTRIES, 2001–2012

(Billions of dollars)

Source: UNCTAD secretariat calculation, based on BIS, Consolidated Banking Statistics database.Note: Core countries are France, Germany and the United Kingdom.

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Exposure to Spain Exposure to Greece Exposure to Ireland Exposure to Italy Exposure to Portugal

Financing the Real Economy 119

mayalsohavehadoppositeeffectssimultaneously,asseemstohavebeenthecaseduringmostof2011and2012,andalsointhefirsthalfof2013.Somepush factors (particularlymonetary conditions) indevelopedcountriesappear tohavehadapositiveimpactoncapitaloutflowstoemergingmarketecono-mies,whileotherpushfactors,suchasanincreaseinperceptionoffinancialriskdiscouragedsuchmove-ments.Thismayexplaintheconsiderablevolatilityofthesecapitalflows,anduncertaintyaboutapossiblenewbigwaveofcapitalinflowstoemergingmarketeconomiessimilartothatof2003–2007.

Whiletheoccurrenceofnewwavesofcapitaloutflowsdependstoalargeextentoncircumstancesin thedevelopedcountries, the impact itcanhaveondevelopingcountrieslargelydependsontheeco-nomicsituationandgovernmentpoliciesinthelatter.inthatrespect,thereweresomeuniquefeaturesinthemostrecentcrisisthatcanprovidevaluablelessonsforthefuture.Unlikepreviousfinancialcrises,asud-denstopofcapitalinflowsdidnotgenerallytranslateinto balance-of-payments problems or domesticfinancialcrises,themainexceptionsbeinganumberofCentralandeasteuropeancountries(asmentionedabove).Consequently,fiscalpolicycouldbeusedforsupportingtherealeconomyratherthanbailingoutthebankingsystem,leadingtoarapidrecoveryofGDPgrowth,althoughnottopre-crisisrates.

Theimpactofthefinancialshocksondevelop-ingcountriesdependedcriticallyontheirpre-crisissituation. external balances played amajor role:historically,capitalreversalshadagreateradverseimpact on countries already running large currentaccount deficits, as theywere forced to suddenlyundertakerecessionaryadjustmentswhentheycouldnolongerfinanceexternalimbalances.Hence,onereasonfortherelativeresilienceofemergingmarketeconomiesisthat,ingeneral,theywerenotrunningcurrentaccountdeficits,atleastnotonthesamescaleasoccurredduringprevioussurgesofforeigncapitalinflows.Severalcountries,includingChina,evenhad“twinsurpluses”–anunusualsituationofsurplusesinboththecurrentandthefinancialaccount–thecounterpartofwhichwasastrongaccumulationofofficialforeigncurrencyreservesand,insomecases,anetrepaymentofexternaldebt.Someofthereasonsfor thehealthycurrentaccountsofmostemergingmarketeconomiesbeforethecrisiswerefavourabletermsof trade for commodity exporters and/or anincreaseinexportvolumesowingtostrongdemand

fromdevelopedcountries.Thesefavourablefactorshadnotexistedinprevious“waves”ofcapitalflows.Anotherfactorexplainingtherelativeresilienceoftheemergingmarketeconomieswasthatinmanyofthemtheauthoritieshadbeenabletopreventexces-sive currencyappreciation through intervention intheforeignexchangemarketorthroughsomeformof capital accountmanagement.Thesemeasureshelpedthemavoid,oratleastcontain,anapprecia-tionoftheirrealexchangerate.othercountries,suchasbrazil,Chile,ChinaandtheRussianFederation,though less successful in this regard, had ratherundervaluedcurrencies(fromahistoricalperspec-tive)atthetimetheircurrenciesbegantoappreciate(around2004–2005)(chart3.9).

The lower vulnerability of emergingmarketeconomies to financial shocks also resulted fromthefactthatmanyofthemhadalreadyexperiencedfinancialcrisesbetweenthemid-1990sandtheearly2000s,which had led to a significant contractionof outstanding bank loans to the private sector(chart 3.10).Consequently, in the years followingthosecrisesmanybankswereunwillingorunabletoincreasetheircreditoperationsastheysoughttoconsolidatetheirbalancesheets.Atthesametime,firms and households restrained their demand forcredit.This explainswhy capital inflows did nothaveastrongimpactondomesticcreditexpansioninseveralofthosecountriesthathadbeenhitattheendofthe“secondwave”ofcapitalinflowsinthelate1990s,suchasArgentina,indonesia,Malaysia,Mexico, the Philippines andThailand. in othercountries, such asbrazil, theRussianFederation,Turkey andUkraine,which had also experiencedfinancial crises earlier, but had again receivedmassivecapital inflows in theyearspreceding the2008–2009globalcrisis,domesticcreditexpandedrapidly.

in lDCs as a group, financial plus capitalinflowsaccounted forabout6percentofGDP in2010–2011,alevelsimilartothatofotherdevelop-ingcountries.MostoftheinflowswereintheformofFDiandofficialdevelopmentassistance(oDA)inthecapitalaccount,whichrepresentedrathersta-blecapital.inaddition,thelDCshavebeenabletoaccumulatereservesforseveralyearsinarowandreduce their currentaccountdeficit toabout1percent ofGDP (chart 3.7).However, the situationvariesconsiderablyamongthesecountries,withoil-exportinglDCspostingcurrentaccount surpluses

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Box 3.1

CAPITAL INFLOwS INTO EMERGING MARkET ECONOMIES: SOME ECONOMETRIC RELATIONShIPS

Thisboxpresentstheresultsofaneconometricexercisethatanalysedthedeterminantsofcapitalinflowsreceivedby19emergingmarketeconomiesbetween1996and2012.

Thedependentvariableiscapitalinflows,asmeasuredbynetcapitalinflowsasapercentageofGDP.

Theretainedexplanatoryvariablesare:

• ThedifferentialbetweentherealGDPgrowthoftheemergingmarketeconomiesandtheG7GDPgrowthrate(G-DiFF).Apositivedifferentialindicatesthattheemergingmarketeconomiesgrewfasterthanthedevelopedeconomies,whereasanegativedifferentialindicatestheopposite.

• Thenationalstockexchangeindices(NSei)measurestheequitymarketperformanceofthecompaniescoveredbytheindex.Achangeintheindexrepresentschangesininvestors’expectationsoftheyieldsandrisks.

• TheChicagoboardoptionsexchangeSpxVolatilityindex(ViX)measurestheexpectedstockmarketvolatilityoverthenext30-dayperiodfromthepricesoftheS&P500indexoptions.TheViXisquotedinpercentagepoints,andhighervaluesindicatethatinvestorsexpectedthevalueoftheS&P500tofluctuatewildlyoverthenext30days.

• Theemergingmarketsinvestmentreturns(eMiR)representthedifferentialbetweentheinterestratesofemergingmarketsandtheUnitedStatesatthebeginningofthequarter,adjustedbytheex-postappreciationrateofthecorrespondingemergingmarketcurrency.itcorrespondstowhataforeigninvestorcanobtainbyborrowinginacurrencyatalowinterestrateandinvestingindomesticassetsthatgiveahigherinterestrate,correctedbytheexchangerateappreciation.

The data

Thecapitalinflowsdatafortheseestimationscovered19emergingmarketeconomies:Argentina,brazil,Chile,China,Colombia,ecuador,india,indonesia,Malaysia,Mexico,Morocco,Peru,thePhilippines,Poland,theRepublicofKorea,Romania,Singapore,SouthAfrica,ThailandandUruguay.Quarterlydatafromthefirstquarterof1996tothefourthquarterof2012wereextractedfromtheiMFbalanceofPaymentsdatabaseandcomplementedbynationalsources.

QuarterlyrealGDPdataweretakenfromtheiMFinternationalFinancialStatisticsandnationalsources.TheywereseasonallyadjustedusingthecensusX12method.Datafortheremainingvariablesweretakenfromthebloombergdatabase,theiMF’sinternationalFinancialStatisticsandnationalsources.

Results

The tablebelowshows the regression resultsbasedonpaneldata.Thepaneldatamodelwithfixedeffectswasestimatedusingfeasiblegeneralizedleastsquares(GlS)alongwithrobuststandarderrors.

Column(1)showsthatforthefullperiodthefourexplanatoryvariableswerestatisticallysignificantforexplainingcapitalinflowsinemergingmarkets.Morespecifically,theresultsindicatethatawiderdifferentialgrowthinGDP,anincreaseinthestockexchangemarketindexofemergingmarketeconomiesandanincreaseintheinvestmentreturndifferentialhadapositiveimpactoncapitalinflowsintoemerging

Financing the Real Economy 121

marketeconomies.Conversely,ahigherdegreeofinvestorriskaversion(asmeasuredbytheViXindex)wasassociatedwithlowercapitalinflowsinemergingmarketeconomies.

Recursivecoefficientestimateswereusedtoevaluatestabilityofthecoefficients.Resultsshowchangesinthecoefficientsacrosstime,indicatingthattherewasabreakaround2005.Thereforethefullperiodwasseparatedintotwosub-periods:1996–2005(firstquarter)and2005–2012.Theregressionresultsarepresentedincolumns(2)and(3).Theyshowthat,exceptforthevolatilityoftheS&P500index,theimpactoftheexplanatoryvariableswasmuchlargerintheperiodafter2005thanintheearlierperiod.eventheGDPgrowthdifferentialisnotmeaningfulforthe1996–2005period.TheseresultsareconsistentwiththeobservationthatcarrytradestrategiesofinvestorscontributedtocapitalinflowsintoemergingmarketeconomiesduringtheperiodoflowinterestratesintheUnitedStates.Thecoefficientsoftheothertwovariableswerefoundtoremainstable.

Short-termcapital inflows(i.e. thedifferencebetweennetcapital inflowsandnet inwardFDi)werealsoregressedbasedonthefourexplanatoryvariables.Forthefullperiod(column4),asexpected,theimpactofinvestmentreturnsonshort-termcapitalinflowswaslargerthanthatontotalcapitalinflows,whereastheotherthreevariablesshowedlowercoefficients.Columns(5)and(6)showresultsforthetwosub-periods.Theypresentsimilarpatternstothoseobservedfortotalcapitalinflows:theimpactsoftheGDPgrowthdifferential,emergingmarketstockmarketindexesandinvestmentreturnsweremuchgreaterintheperiod2005–2012thanintheperiod1996–2005.

REGRESSION RESULTS FOR EMERGING MARkET ECONOMIES, 1996–2012(Dependent variable: capital inflows as a percentage of GDP)

Capital Inflows Capital Inflows (excl. FDI)

(1) (2) (3) (4) (5) (6)Period 1996–2012 1996–2005 2005–2012 1996–2012 1996–2005 2005–2012

Pull factorsLn(NSEI) (+) 1.704*** 1.068*** 3.421*** 1.272*** 0.800*** 3.117***

Push factorsVIX (-) -0.115*** -0.097*** -0.111*** -0.094*** -0.080*** -0.090***

Combination of both factorsG-DIFF (+) 0.135*** 0.050 0.321*** 0.110*** 0.069** 0.263***EMIR (+) 0.183** 0.099** 0.250*** 0.204*** 0.129** 0.277***

Number of observations 68 37 32 68 37 32Number of countries 19 18 19 19 18 19Total pool (unbalanced observations) 1 066 525 559 1 066 525 559

R-squared 0.445 0.447 0.509 0.336 0.326 0.416F-test 33.096*** 19.389*** 25.302*** 23.94*** 11.572*** 17.347***Durbin-Watson 1.442 1.533 1.740 1.465 1.616 1.710F-test on fixed effects 31.010*** 19.038*** 25.201*** 15.938*** 9.264*** 15.947***R-squared (without fixed effects) 0.148 0.092 0.094 0.153 0.115 0.103

Note: Estimation used Generalized Least Squares with cross-section weights and was based on panel data and quarterly data. *** Significant at 1 per cent. ** Significant at 5 per cent. * Significant at 10 per cent.

Box 3.1 (concluded)

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andnon-oilexportersrelyingonforeigncapitalforfinancingimportantcurrentaccountandfiscaldeficits(UNCTAD,2012).

Foreign reserve accumulation and improveddebtmanagementhavebeentwoeffectivestrategiesadoptedbydevelopingcountriestoshieldthemselvesfromthevolatilityofcapitalflowsandinternationalfinancialshocks.Duringthe2000sseveraldevelop-ing countries accumulated large external reservesthroughmarket intervention inorder toavoidcur-rency appreciation arising from capital inflows,andasaself-insurancestrategyagainst theriskofsuddenstopsandliquiditycrises.Foreignexchangeaccumulation in pre-crisis times enableddevelop-ingcountriestowithstandadverseconsequencesofcapitaloutflowsinthemonthsfollowingthecollapseoflehmanbrothers.Contrastingwithmanyofthosecountries’ responses tofinancial crises in the late1990s,thistimetheydidnotdefendfixedexchangeparitiesatanycostbyadoptingtightmonetaryandfiscal policies; rather, they allowed their curren-cies to depreciate,with central banks selling partof their international reserves inorder toavoidanuncontrolleddepreciation.Thisreflectedpragmaticandflexible approaches to exchange rate policies,which preferred intermediary regimes rather than“cornersolutions”(i.e.freefloatingorirrevocablypeggedexchangerates).itgavethemmoreroomformanoeuvre inhandling thefinancialcrisisand forimplementing countercyclical policies in responseto theglobalrecession. italsoshowedthat, in theabsence of an international lender of last resort,foreign reserves offer a natural protection againstfinancialmarketshocks.

The greater resilience of several developingandemergingmarketeconomiestoadversefinancialeventswasalsoduetotheirlowerlevelsofexternaldebtanditsmorefavourablecurrencycompositioncomparedwithearlierepisodes.Priortotheglobalfinancialcrisis,mostofthesecountrieshadmanagedto sharply reduce their average debt ratios and todeveloporexpanddomesticmarketsfortheissuanceofdebtinstrumentsdenominatedinlocalcurrencies.Agreaterrelianceondomesticcapitalmarketsforthefinancingofpublicexpenditurehelpsdevelopingcountries to reduce their vulnerability to lendingbooms and exchange-rate effects generated bysurgesofcapitalinflowsfollowedbysuddenstopsand reversals of suchflows.Although it does notsolve the eventual problemof a foreign exchange

Chart 3.9

REAL EFFECTIVE ExChANGE RATES (REER), SELECTED COUNTRIES, 1990–2012

(Index numbers, average for 1990–1995 = 100)

Source: UNCTAD secretariat calculations, based on UNCTADstat.Note: REER are calculated using GDP deflators.

0

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Argentina BrazilChile Mexico

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Russian Federation South AfricaTurkey Ukraine

Financing the Real Economy 123

Chart 3.10

bANk CLAIMS ON ThE PRIVATE SECTOR, SELECTED COUNTRIES, 1990–2012(Per cent of GDP)

Source: UNCTAD secretariat calculations, based on IMF, International Financial Statistics database.

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1990 1995 2000 2005 2010

Argentina

2012 0

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India

2012 0

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1990 1995 2000 2005 20100

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Republic of Korea

20121990 1995 2000 2005 2010

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Malaysia

20121990 1995 2000 2005 2010

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80Philippines

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20120

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Nigeria

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20120

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20120

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Ukraine

2012

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shortage,itshouldbethefirstoptionforfinancingexpenditureindomesticcurrency.Debtdenominatedin local currency also increases policy spacebecause it allowsexternal shocks, suchas suddencapitaloutflows,ariseinglobalinterestratesorthewideningofsovereignyieldspreads,tobecounteredby currency devaluationswithout increasing thedomesticcurrencyvalueofthatdebt.Furthermore,debt denominated in local currency allows thegovernmentalast-resortoptionofdebtmonetizationinatimeofcrisis.Thesolepossibilityofmonetizingdebtdramaticallyreduces the insolvencyrisk,andconsequentlylowerstheriskpremiumonthedebt.

Summingup,policiesaimedatminimizingriskshaveplayedanimportantroleinhelpingdevelopingcountriesrideouttheglobalcrisis.Theseincludetheaccumulationofforeignreserves,thedevelopmentofdomesticdebtmarketsandtheissuanceofdebtinstrumentsthatprovideinsuranceagainstdomesticandexternalshocks.Althoughsuchinsurancepoli-ciesmayentailsomecosts,12theyreducedevelopingcountries’vulnerabilitytofinancialshocksandthelikelihoodofdisruptivefinancialcrises,thecostsofwhichcanbeincommensurablyhigher.

Theobservationthatdevelopingcountrieshavebeenbetterabletowithstandshocksoriginatingininternationalcapitalmarkets thaninpreviousdec-adesdoesnotmean,however,thattheyareshieldedagainstfinancialturbulenceinthenearfuture.Someemergingmarket economies, particularlybrazil,China,theRussiaFederationandTurkey,haveseenrapidgrowthindomesticcredit,evenafterthe2008crisis,whichmaybepartlyrelatedtocapitalinflows(chart 3.10).These same countries have experi-encedrealappreciationoftheirdomesticcurrencies,althoughinbrazilandTurkeytherehasbeenapartialreversal.However, theyremainexposedtofurthersurgesincapitalinflows,whichmightputadditionalpressureon their credit andcurrencymarkets,butalso tosuddencapitaloutflows,whichwould leadto steep corrections in thosemarkets. in addition,thosecountriesthatpresentlyrunsignificantcurrentaccountdeficitsarelikelytobefacedwithbalance-of-payments problems.The degree of financialvulnerabilitydependstoalargeextentonhowcapitalinflows(andthedomesticcredittheymaygenerate)areusedintherecipienteconomy:ifalargepropor-tionoftheflowsisusedforfinancingthepurchaseofrealestate,leadingtoahousingbubble,thereisa

riskofgreaterfinancialfragilitythanifitisusedforproductiveinvestment.

Theinstabilityofcapitalmovementstodevel-oping countries since the crisis,with a temporaryreturntotheirpreviouspeakinthefirsthalfof2011andasubsequentfall thereafter,contrastswiththeexperience of the last fewdecades. Previously, ittookseveralyearsafteracrisisbeforeanewwaveofcapitalflowstodevelopingcountriescommenced,anditwouldlastforseveralyearsbeforereceding.investorsdriventodevelopingcountriesin2010andmostof2011seemtohavebeenencouragedbytheabilityofthesecountriestoresumetheirveryrapidpre-crisisGDPgrowthratesandbytheperceptionthat theirfinancial systemsweremore stable thanthose of developed countries.However, by thendevelopedcountrieswerealsorecoveringfromthecrisis,andconsequentlyinvestmentsthereappearedlessrisky.but,asparadoxicalasitmayseem,wors-eningprospectsindevelopedcountriesinthesecondhalfof2011,includinghigherperceivedrisksrelat-ingtothesovereigndebtofsomeofthem,curtailedcapitalflowstowardsbetterperformingdevelopingcountries.Thisseemstoindicatethatinstabilityinthedevelopedcountriesreinforcedtheriskaversionoffinancial agents, particularly the largefinancialinstitutionsthatarethemaindriversofinternationalcapitalflows.Moreover,someoftheseinstitutionsstill needed to consolidate their balance sheets byrecapitalizingandcleaninguptheirbalancesheetsbysheddingnon-performingloans.

Atpresent,theprospectofsomeimprovementingrowthperformanceandlowerperceivedrisksinsomedevelopedcountriesarecreatinguncertaintyaboutthefutureofcapitalflowstodevelopingandemergingmarketeconomies.ontheonehand,lowerriskscouldfavouraportfolioreallocationinsearchofgreaterprofitability,whichcouldleadtoasurgeofcapitaloutflowstotheselattercountries,ashappenedduringthefirsthalfof2013.butontheotherhand,ifprospectsofeconomicrecoveryandaperceivedriskofmountinginflationleadtotightermonetarypoli-ciesindevelopedcountries,theremightbeadrasticreversalofcapitalflowsawayfromemergingmarketeconomies.Forexample,thesoleannouncementofa future,butnon-imminent,discontinuationof theassetpurchaseprogrammebytheFederalReserveinJune2013promptedareversalofcapitalflowstoemergingmarketeconomies.

Financing the Real Economy 125

inconclusion,itisnecessarytoexercisecautionwithregardtocross-bordercapitalflows,especiallyinaclimateofhighuncertainty,whensentimentsmorethanfactstendtodrivecapitalmovements,potentiallylead-ingtoself-fulfillingprophecies.Developingcountries

shouldadoptprecautionarymeasures,asdiscussedinthenext section,bearing inmind that“theseedsofemergingmarketcrisesaresowninthebuild-upphase,asinflowsdwarftheabsorptivecapacityofrecipientcountries’capitalmarkets”(Haldane,2011:2).

1. Theroleandimpactoffinancialmarkets: a reassessment

(a) Financial instability

inhisHistory of Economic Analysis,Schumpeterobserved:“Peoplemaybeperfectlyfamiliarwithaphenomenonforagesandevendiscussitfrequentlywithout realizing its true significance andwithoutadmitting it into theirgeneral schemeof thought”(Schumpeter,1954:1081).Hemadethisremarkinthechapteronmoney,creditandcycles.indeed,thisistheareawherethegapbetweenconventionaltheory–basedonthehypothesisofefficiency,rationality,neutralityandself-regulatingmarketmechanisms–andactualexperienceisthemostevident.Thepresentcrisis isanewreminderof the inadequacyof thattheoreticalframework.Thistimethemessageseemstobestronger,becauseattheepicentreofthecrisisarethemostsophisticatedand“deep”financialsystemsof developed countries.Thus, financial dysfunc-tioncannolongerbeattributedtounderdevelopedfinancial institutions or governance shortcomings,whichwerecommonlyconsidered tobe thecauseof the repeatedfinancial crises in developing andtransitioneconomiesinthe1980sand1990s.Thereisnowincreasingrecognitionoftheneedtoreintroducethenotionoffinancialinstabilityinthetheoreticalframework(borio,2013;blanchard,2013).

oneessentiallessonofthecrisisrelatestotheassumed self-correctingmechanisms of financialmarketsandtheirsupposedstabilizingroleforthe

entireeconomy.Historically,repeatedfinancialcriseshavefollowedfairlysimilarpatterns,regardlessofwhereandwhentheyhaveoccurred,whichsuggeststhat their cause lies in the verynature offinance.external shocks and occasionalmismanagementmayaccentuatefinancialvulnerabilityor triggerafinancialcrash,buttheydonotbythemselvesdesta-bilizewhatareconsideredintrinsicallystablemarkets(Kindleberger,1978;Galbraith,1994;ReinhartandRogoff,2009).Rather,recurrentfinancialinstabilityresults from the fact thatfinancialmarketsdonotfunctionlikegoodsmarkets,wheresuppliersandpur-chasersareclearlydistinctandwheresomematerialfactors(e.g.productivity,costsandstocks)setlimitstopricemovements.infinancialmarkets,suchlimitsaremuchscarcerorsimplydonotexist(Agliettaandbrand,2013;Wicksell,1935).Unlikeinothermar-kets,mostagentscanbebuyersaswellassellersinfinancialmarkets.Thismayleadto“manias”,whenmostinvestorsanticipatepriceincreasesandbuyersoutnumbersellers,followedby“panics”,whenpricesareexpectedtofallandbuyersdisappearfromthemarket.intimesof“euphoria”,strongexpectationsofpriceappreciationwilldriveupdemandforsomefinancialassets,whichinturnwillincreasethepricesofthoseassets,therebygenerating(atleastforsometime)aself-fulfillingprophecy.

Consequently,onfinancialmarkets,unlikeothermarkets,risingpricesencourage–ratherthandiscour-age–demandforfinancialassets,andtheoppositeistruewhendemandisfalling, thusleadingtoover-shooting. investors canmaximize their gains byincurringdebt:whentheexpectedgainsarehigher

D. Lessons and policy recommendations

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thanthecostofthedebt,higherleveragingincreasestheratioofprofitstocapital.ifborrowersareabletoprovidecollateralintheformoffinancialassetsthatare rising inprice, lenderswillbewilling tomeettheirdemandforcredit.Andasthatcreditispartlyused forbuyingmorefinancial assets, theirpriceswillcontinuetoincrease,therebyfeedingbackthewhole process and inflating a speculative bubble.inotherwords,thereisaclosecorrelationbetweencreditsupplyanddemand:theybothgrowinparallelduringexpansionaryphasesandvalidatetheincreaseinassetprices,withnoendogenousadjustmentforcesinthefinancialmarketstostoptheprocess(Agliettaandbrand,2013).Whateventuallyleadsfrommaniastopanics is anecdotal: at somepoint anumberoffinancialinvestorsandbankschangetheirperceptionofrisk,andtheensuingherdbehaviourmakesthefinancialmarketsabruptlyturnfrombullishtobear-ish.Thedownwardphaseisnormallymoreabruptand spectacular than the upward phase, althoughequallyirrational.Financialcrisesarethusrootedintheeuphoriaphase.

Theperceptionthatfinancialmarketsareinher-entlyunstableandpotentiallyirrationalchallengestheorthodoxviewthattheyareessentiallynotonlystableandefficientthemselves,butalsohelptosta-bilizetheeconomyasawhole.inthatview,accessto credit is supposed to smooth expenditure, asnon-financial agents canborrowduringbad timesandrepaytheirdebtsduringgoodtimes.Financialmarketsarethereforeseenasplayingacountercy-clical role. in addition, it is argued that financialmarkets help “discipline” policymakers, as theywillreactagainst“marketunfriendly”policiesthatmightundermineeconomicstability.Therefore,sotheargumentgoes,policymakersshouldnotregulateintrinsically stablefinancialmarketsbeyond somebasicmicroeconomicprecautionary rules (such ascapitalratios);instead,themarketsshouldregulatepolicymakers.However, actual experiences, someofwhichhavebeenreviewedinthischapter,showthat,onthecontrary,financialmarketshaveastrongprocyclical bias, and inmanycountries theyhaveencouraged, rather than restrained, unsustainablemacroeconomicpolicies.

(b) International capital flows

The divergence between these two views isparticularlysharpwithrespecttocross-bordercapital

flows(brunnermeieretal.,2012).Formanyyears,the prevalent viewconsidered almost anykindofforeign capital flows to developing countries asbeneficial.Theywereseenasconstituting“foreignsavings” thatwould complement national savingsoftherecipientcountriesandleadtohigherratesofinvestmentthere.

This view has been challenged on both atheoreticalandempiricallevel.Theoretically,apre-existing stockof savings isnotaprecondition forinvestment,accordingtothealternative(Keynesian/Schumpeterian) view. investment can befinancedthroughbankcredit,andsavingsareanendogenousvariableresultingfromtheincomegeneratedintheeconomicprocess(seeTDR 2008chap.iiiandiV;Dullien,2009).inotherwords,asthecausalityrunsfrom investment to (ex-post) savings, largerflowsof foreign capital do not automatically increaseinvestment.This conceptual view is supportedbytheevidenceofhugecapitalinflowscoexistingwithstagnating investment rates (e.g.Africa andlatinAmericainthe1990s)andsubstantialincreasesinfixed investment,despite strongoutflowsornega-tive“foreignsavings”(e.g.ArgentinaandChinainthe2000s).Moreover,itcannotbeassumedthatallforeign capital finances investment in productivesectors. it is not because they are called “foreignsavings”,andthat“savingsequalsinvestment”,thatcapitalinflowswillautomaticallyincreasedomesticinvestment.evenFDidoesnotnecessarilyconsistofrealinvestment,sincesomeofthoseflowsincludemergersandacquisitions–includingprivatizations–andcreditsfromheadquarterstoaffiliatesoftrans-nationalcorporations(TNCs).

Asnotedearlier,experiencewithinternationalcapital flows shows that they repeatedly affectedeconomicstability:theyledtoexcessiveexpansionofdomesticcreditandgeneratedbubblesinequity,realestateandotherfinancialmarkets;theyalsocausedanappreciationofthedomesticcurrency,reducedthecompetitiveness of domestic producers in interna-tionalmarkets,boosteddemandforimportedgoodsandservices,andgeneratedorincreasedthecurrentaccountdeficit.13ofcourse,therearealsoexamplesofcapitalinflowsfinancinghigherinvestmentrates,either directly, aswith greenfield investments, orindirectly through loans effectively used forfixedcapital formation and/or for financing imports ofcapitalgoods.Therefore,whatmattersfordevelopingcountriesisnotsimplyaccesstoexternalfinancing,

Financing the Real Economy 127

butalsoadegreeofcontroloverhowthatfinancingisused.Countriesneedtobeselectiveintermsofthequantity,compositionandtheiruseofforeigncapital.

(c) Money, credit and banks

Thefactthatsavingsarenotaprerequisiteforhigherfixedcapitalformationleadstotheconclusionthattheprovisionofcredit(morespecificallybankcredit), rather thanmoney, shouldbe the focusoftheanalysis(Stiglitz,2013).Creditexpansioncre-atesdeposits,andconsequentlymoney,andnottheotherwayaround(Schumpeter,1954:1079–1080).This contrastswith themonetarist tradition thatassumesthat“high-poweredmoney”issuedbycen-tralbanksdeterminestheamountofcreditandothermonetaryaggregates–anassumptionthathasbeeninvalidatedbyrecentexperience,whichshowshowmassivemoneycreationbyacentralbankcanhavelittle,ifany,impactintermsofincreasingcredittothe private sector.More importantly, by focusingexcessively on the quantity ofmoney, economistsandmonetaryauthoritieshavegivenlessimportancetohowitshouldbeutilized.Moneyisnotneutral,inparticularbecauseitisnotdistributedevenlyamongalleconomicactorswhenitiscreated.oversimplifiedmonetarist views ofmonetary creationmiss thisessentialpoint,andyetitiscentraltothewritingsofCantillon,WicksellandSchumpeter,forinstance.

Thechannelthroughwhichsupplementarypur-chasingpowerisintroducedinaneconomy,thekindsofagentsthatreceiveitandhowitisutilizedhaveanimpactontheamountandcompositionofaggregatedemand(i.e.credithasdifferenteffectsdependingonwhetheritisusedforconsumption,investment,importsorexports)andonthesectoralstructureofaneconomy(i.e.therelativeimportanceofagricul-ture,manufacturesandservices).Theyalsohaveanimpactoneconomicpower;forexample,creditmayconcentratepropertybyfinancingtherichorreduceitsconcentrationbysupportingmicro-,small-andmedium-sized firms.banks are keymechanismsthroughwhichthispurchasingpowerisintroducedinaneconomy.inordertoperformefficiently,theymustdiscriminatebetweengoodandbadprojects,andreli-ableandunreliableborrowers,insteadofbehavinglike passive intermediaries followingmechanicalprotocols,orlosinginterestintheirborrowersafterhavingsecuritizedtheirloansandtransferredtherisktoanotherentity.

Shifting attention frommoney to credit alsoimpliesmakingpolicymakersresponsiblenotonlyformonetarystabilitybutalsoforfinancialstability.Thelatestcrisishasrevealedthatmonetarystabil-ity,inthesenseofpricestability,cancoexistwithseverefinancialinstability.evenworse,insomecasesmonetarystabilityhasincreasedfinancialinstability.in the euro zone, for example, the eliminationofexchangerateriskandtheprevalenceoflowinflationfavouredlargecapitalflowsfrombanksinthecorecountriesofthecommoncurrencyareatocountriesintheperiphery,andtherewasavirtualdisappear-anceofinterestratedifferentialsbetweenthesetwosetsofcountries.However,thosecapitalflowswerenotusedforspurringcompetitivenessandproduc-tioncapacities:instead,theyfedassetbubblesandincreased current account deficits.This amplifiedintraregionaldisparities,ratherthanreducingthem,andledtothedifficultsituationinwhicheuropefindsitselftoday.Thisshowsthat,importantly,itwasnottheamountofmoneycreationortheoverallavail-abilityoffinancialresources,butwhoreceivedthoseresources andhow theywere used, thatmattered.Monetarystabilitybasedonafixednominalexchangerateledtosimilaroutcomesinmanydevelopingandtransitioneconomiesinpreviousdecades,particularlyinlatinAmericaandSouth-eastAsia.14

2. Counteringfinancialinstability

Giventhatfinancialsystemsarepronetosig-nificant instabilitywith system-wide implications,andthatself-regulationandself-correctingmecha-nismscannotbe reliedupon,monetaryauthoritiesandsupervisoryinstitutionsneedtoassumegreaterresponsibilityforfinancialstabilityindeveloped,tran-sitionanddevelopingcountriesalike.Thisinvolvesmacroprudential policies relating to internationalfinancial integration,which aim at addressing thepotentiallydestabilizingeffectsofcross-bordercapi-talflows.Atthenationallevel,italsorequirespolicymeasuresandinstitutionalreformsthatshouldavoidexcessiveleveragingwithoutdiscouragingcreditforproductiveinvestment.indeed,proactivepoliciesbycentralbanksmaybeneededtospurinvestmentandgrowth,andcreateconditionsconducivetofinancialstability. Financial stabilitywill not be sustainedin the longruninaneconomythatdoesnotgrowandcreatejobs,becausesoonerorlaterbankswill

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accumulatenon-performing loans in their balancesheets.There isalsoaneed toreconsiderhowthefinancial sector is organized, such as separatingcommercial banking and investment banking, andextending transparency requirements, regulationsandtaxationtocover“shadowbanking”andoffshorecentresaswell.Finally,reformofthemacroeconomicframework is essential, as the existing frameworkhas contributed significantly to the generation ofunsustainablefinancialprocesses.

(a) Exchange rates and capital account management

Thepotentiallypositiveroleofforeigncapitalineconomicdevelopmentisunderminedbytheriskof it becoming amajor source of instability.Thishighlightstheproblemsarisingfromaninternationalfinancialsysteminwhichasmallnumberofnationalcurrenciesofdevelopedcountries(particularly theUnitedStatesdollar)areusedasinternationalmoney.in each international credit cycle,monetary policyinthesecountrieshasbeendeterminedbydomesticconsiderationsandgoals,suchassupportingdomesticeconomicactivityandeasingfinancialdistressinsomecases,orcontrollingdomesticinflationinothers.littleor no consideration is given to the effects of thesepoliciesontheglobaleconomythroughtheirimpactonexchangeratesandcurrentaccountbalances.

Moreover,often,“sudden-stop”episodesofcap-italinflowshavehadanegativeimpactonemergingmarketeconomiesbytriggeringbalance-of-paymentscrises, usually combinedwith banking andfiscalcrises.Andwhensuchinflowshavebeentoolargetobeproductivelyabsorbedinthosecountries,theyhavegeneratedpricedistortionsandmacroeconomicimbalances,eventually leading tocapital reversalsandfinancial collapse.Thus, often, it is not onlyvolatile capitalmovements to and fromemergingmarkets,butalso,andprimarily, themagnitudeofthosemovements vis-à-vis the recipient countriesthathaveadverselyaffectedtheirmacroeconomy.Thiscanleadtothe“bigfishsmallpondproblem”,asstressedinHaldane(2011):asbigfish(i.e.largecapi-talflowsoriginatingindevelopedcountries)enterthesmallpond(therelativelymodestfinancialmarketsof capital-importing emergingmarket economies)theycancauseripplesrightacrosstheinternationalmonetarysystem,andnevermoresothanintoday’sfinanciallyinterconnectedworld.

Theexistinginternationalmonetaryandfinan-cial system isnot equippedwithmechanisms thatpromoteexchange rate stability,prevent largeandpersistent current account imbalances and ensuresmoothandorderlyadjustmentsto,andcorrectionsof,disturbances.ithasbeenunabletorestraindesta-bilizingcapitalmovementsandorganizeanexchangeratesystemthatwouldreasonablyreflecteconomicfundamentals.Theseshortcomingshavebecomeevermoreevidentanddamagingwiththedeepeningoffinancialglobalizationandtheincreasingvolumeofcross-bordercapitalflows.

in the present (non-)system, the burden ofadjustments to global imbalances falls entirelyondeficit countries that dependon externalfinancialresources,andnotonanyof themajoractors:bigsurplus economies donot needfinancing, and thecountrywith the largest deficit issues themajorinternational reserve currency.This introduces arecessionarybiasintothesystem,becausethelesspowerfuldeficitcountriesareforcedtocutdemand,whilethereisnoobligationforsurpluscountriestoincreasedemand.

The existing international financial arrange-ments have also failed to prevent the disorderlyincrease in short-term capitalmovements,whichisamajorfactorcontributingtoeconomicinstabil-ity.Countrieswishingtoavoidtheprocyclicalanddestabilizingimpactofcapitalflowshavetoresorttounilateralmeasures,suchasforeign-exchangemar-ketinterventionorcapitalcontrols.Suchmeasureshavebeenrelativelysuccessfulincurbingundesiredcapitalmovementsortheirimpactonthedomesticeconomy.However,aneffectivecontrolofpotentiallydestabilizingfinancial flows requiresmultilateralarrangements,whicharealsointheinterestofcoun-tries fromwhich suchflowsoriginate.Theglobalfinancial crisis has shown that unregulated capitalflowsgeneraterisknotonlyinrecipientcountries,butalso insourcecountries,sincesolvencyof thelatters’banksmaybethreatenediftheyareinvolvedinforeigncountries’assetbubbles.Thus,financialsupervisionneedstobeappliedatbothendsofcapitalmovements.

Greaterstabilityofexternalfinancingfordevel-opingcountriesisdifficult–ifnotimpossible–toachievewithoutbroaderreformoftheinternationalfinancial andmonetary system.Theexperienceofthefinancialandeconomiccrisishasmadeitclear

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thatweakinternationalarrangementsandinstitutions,andtheabsenceofinternationalrulesandregulationsinthisarea,carryhighrisksnotonlyfordevelopingcountriesbutalsoforthemostadvanceddevelopedcountries.Yetthewillforinternationalcooperationtoundertakethenecessaryreformsisstilllacking.Under existingmonetary andfinancial conditions,andintheabsenceofinternationalreforms,develop-ingandemergingmarketeconomiesneedtodesignnational, and,where possible, regional strategiesaimedatreducingtheirvulnerabilitytointernationalfinancialshocks.

As longas therearenomultilaterallyagreedrulesgoverningtheexchange-ratesystem,thetaskofreducingtherisksofcurrencymisalignmentandexchange rate volatility remainswith the govern-ments andmonetary authorities of each country.Theserisksarelikelytoincreaseinthecurrentglobalcontext of persistent growth disparities betweenthemajorreservecurrencycountriesandemergingmarketeconomies,andcouldwellbeaccentuatedasthelatterandotherdevelopingcountriesshift toastrategythatplacesgreateremphasisthaninthepastonincreaseddomesticdemandasadriverofgrowthanddevelopment.

Followingtheirexperienceofthehighcostsofadopting“cornersolutions”forexchangerates(i.e.fullyflexibleor irrevocablypegged),mostemerg-ingmarketeconomieshaveturnedtowardsamorepragmaticmanaged floating regime.This allowsflexibleinterventionbycentralbankstoavoidbothexcessivevolatilityandunsustainablerealexchangeratesresultingfromspeculativefinancialoperationsratherthanfromfundamentals.15

in addition, regional financial cooperationcan support efforts to stabilizemacroeconomicconditions. Since the 1960s, some regions haveused certainmechanisms thatmake it possible toreducedependenceonforeigncurrencyforregionaltrade, such as clearing payment systems and theuseofdomesticcurrenciesforbilateraltrade.otherinstitutionsprovidebalance-of-paymentsfinancingwithoutundesirableconditionalitiesattached.Someregionalarrangementsalsofacilitatethemanagingofexchangerates,forinstancethroughcredit(orswap)agreementsamongcentralbanksorthepoolingofreserves (e.g. thelatinAmericanReserves Fund(FlAR), theArabMonetaryFund (AMF)and theChiangMaiinitiative).Astheseregionalinstitutions

offer supportwithout harsh conditionalities, theyprovideaneffectivetoolforcountercyclicalpolicies.

Destabilizing effects and a procyclical biascausedbycapitalflowscanalsobeprevented,oratleastmitigated,byresortingtocapitalcontrols,whicharepermittedundertheiMFArticlesofAgreement.There is extensive experiencewith such controlsinbothdevelopedanddevelopingcountries.TheyweretheruleintheUnitedStatesinthe1960sandineuropeuntilthe1980s.inthe1990sand2000s,some emergingmarket economies (e.g.Chile andColombia)sought todiscourageshort-termcapitalinflowsthroughtaxationortheimpositionofnon-remunerateddeposits,whileothersimposedbarrierson short-termcapitaloutflows (e.g.ArgentinaandMalaysia).More recently,brazil also introducedtaxesoncapitalinflows.Theuseofcapitalcontrolsisbeingincreasinglyacceptedininternationalforums,althoughstillwithsomereservations.Forinstance,theiMFhasacceptedthatcapitalcontrolsarelegiti-mateinstruments,butitsuggestsresortingtothemonlyinsituationswhenabalance-of-paymentscrisisisalreadyevidentandafterallothermeasures(e.g.monetaryandfiscaladjustment)havefailed.16Theproblemwithsuchanapproach is that itdoesnotrecognizethemacroprudentialrolethatcontrolscanplayinpreventingsuchacrisisinthefirstplace.

(b) A broader mandate for central banks

Toachievethegoaloffinancialstability,centralbanksandothereconomicauthoritiesneedtoadoptacoordinatedpolicyapproach.Notonlyshouldthemandatesoftheformerbebroadened,butalsothenumberandkindsofinstrumentstheycanuseshouldbeincreased,includingformacroprudentialregula-tionandforkeepingtrackofwhatisbeingfinancedintheeconomy.Allthisrequiresareassessmentoftheideathatcentralbanksmustmaintaintheirinde-pendence(blanchard,2013).Therationalefortheirindependencewastokeepthemfreefrompoliticalpressures as they implemented their (supposedly)technicalresponsibilityofcontrollinginflation.evenincaseswheretheirmandatewaslimitedtoonesinglegoal(monetarystability)withonesingleinstrument(policyinterestrates),their“technical”naturewasdebatable.Withtheprogressivebroadeningoftheirmandateandtheiruseofmoreinstruments(alreadyunderway),theyhaveassumedwiderresponsibilities

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inacomprehensiveapproachtomacroeconomicandfinancialpolicy.

Theneedforreconsideringtheroleofcentralbanks,andwithittheconceptoftheir“independence”forundertakingthesoletaskofensuringstabilityofpricesofgoodsandservices,hasneverbeenmoreevident thanduring the latestfinancial crisis.Thecrisisobligedcentralbankstotakemoreandmore“unconventional”measures,whichhighlightedthegap between the theoretical basis for the conceptofcentralbankindependenceandtheneed,derivedfromexperience,toinvolvethemonetaryauthoritiesineffortstostabilizefinancialmarketsintheinterestsoftheeconomyasawhole.Theconventionalviewholds that the privatefinancial sector is efficient,eventotheextentofbeingabletoeasetheimpactofshocksontherealeconomy.itexcludesthepossibil-ityofmismanagementbyfinancialinstitutionsandmarketsontheassumptionthattheyalwayshavecor-rectinformationaboutcurrentandfutureeconomicdevelopments,andthatitisgovernmentmismanage-mentthatleadstofinancialcrises.Thepresentcrisishas turned thathypothesisupsidedown, as itwascausedbytheprivatesector.Centralbankindepend-encefromgovernmentdidnotpreventthefinancialcrisis,andthecombinedactionofcentralbanksandgovernmentswas indispensable for responding tothecrisis,includingbailingoutinstitutionsthatwereconsidered“toobigtofail”.

Afurtherstepforwardwouldbetoacceptthatcentralbanksmustplayanactiveroleintheimple-mentation of a growth and development strategy.Monetary stability, in the sense of price stability,is insufficient to secure stablefinancial conditionsfor therealeconomy.Moreover,financialstabilitydependsontheperformanceoftherealsectoroftheeconomy,because,inseverecrisissituations,bankshavetendedtoaccumulatenon-performingloansandeventuallyfail.Thus,supportingeconomicgrowthshouldnot be consideredmerely a supplementaryresponsibilityofcentralbanks;itconstitutestheverybasisoffinancialandmonetarystability.

(c) Reconsidering regulation of the financial system

Financialsystemsindevelopingcountriesrequireappropriate regulations aimed at ensuring that theyservetherealeconomyandthedevelopmentprocess.

Moreover, in seeking to achieve financial stabil-ity, the regulations should not hamper growth byundulyrestrictingcredit.inparticular,theyshouldencourage long-term credit to finance productiveinvestment.indeed,thereisatwo-wayrelationshipbetweenfinancial stability andgrowth, in the sensethatwithoutfinancialstabilityitwouldbedifficulttoachievegrowth;on theotherhand, inasituationofeconomicstagnation,loanscouldveryeasilybecomenon-performing,thusposingarisktofinancialstability.

Several developed countries, having beenseverelyaffectedbyfinancialcrises,areintroducingorconsideringfar-reachingchangesinbankregula-tions.Someofthesechangeshavebeenformulatedby thebaselCommittee onbankingSupervision(bCbS)throughthebaseliii rules,andothersbytheFinancialStabilityboard(FSb)aswellasotherbodies.Moreover,thesenewrulesarebeingintro-ducedorconsiderednotonlyindevelopedcountries,butalso,toalargeextent,theyareshapingregulatorysystemsindevelopingandemergingmarketecono-mies.Forinstance,baseliiicapitalstandardshavealreadybeen implemented in11 (outof28)baselCommitteemember jurisdictions, seven ofwhichareemergingmarketeconomies(China,HongKong(China),india,Mexico,SaudiArabia,SingaporeandSouthAfrica),withArgentina,brazilandtheRussianFederationplanningtoimplementthembytheendof2013(biS,2013).

Capitalrequirementsarethemainaspectofthestrengthenedrules.Proposalsnegotiatedatbaseliiiaimtoreviseandextendtheexistingbaseliandiicapitalrequirementsandestablishasimpleleverageratiobetweenassetsandcapital.17Microprudentialregulationsofthiskindaretobesupplementedwithanadditionalmacroprudentialoverlay,suchastheuseofcapitalbuffers,sothatintheeventofthepricesoftheirassetsfalling,bankswillnotfindthemselvesin non-compliancewith capital requirements andhavingtodemandextracapitalwhencreditgrowthdevelopstoorapidly.Also,forthefirsttime,baselruleswillincludeliquidityrequirements,butthereisstilladebateabouttheirprecisedefinitionasbanksarenotinagreementoverthesenewrequirements.

Themain idea behind these refurbished andstrengthenedrulesistoreducerisksofbankfailureandtheneedforpublicbailoutsbycontainingexces-siveleveraging.Theyalsoseektodeterbanksfromfundingmedium-andlong-termlendingbyresorting

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tothewholesalemarketforveryshort-termborrow-ing,ratherthanusingastabledepositbase.

Criticsarguethatbaseliiiregulationsarestillprocyclical,andremaingearedtoevaluatingriskasestimatedbythemarkets,whichhaverepeatedlybeenseentofailinthismostimportanttask.Theyarealsoconsideredtobeoverlycomplex,evenfordevelopedcountries, and probablymore so for developingcountries.inaddition,verylittleprogresshasbeenmade concerning the “too-big-to-fail” institutionsorincopingwiththe“shadowbanking”partofthefinancialsystem.Withregardtothelatter,thereisacomplexdebateabouthowtoexercisegreatersuper-visionofderivativemarkets’over-the-counter(oTC)operations, including requiring public registrationandclearingmechanisms.

Whether the regulatory capital frameworkofthebaselaccordsshouldbeappliedindevelopingcountriesisanopenquestion.infact,baselaccords,startingfrombaseliinthelate1980s,weresupposedtoestablishalevelplayingfieldforlargeinternation-allyactiveinstitutions.For instance, in theUnitedStates, only a few institutionswere supposedlyrequiredtofollowthoserules,whiletherestofthesystemwouldcontinuetoberegulatedinthetradi-tionalway.Fromthepointofviewoftheinternationalfinancialsystem,thereisnoreasonwhybanksfromdevelopingcountriesshouldfollowthesamerulesaslargeinternationalbanks.Progressively,however,baselruleshavebecomeageneralstandard:everycountryissupposedtoapplythem,evenifnoneoftheir banks is amajor active international player.More specifically, Financial SectorAssessmentPrograms(FSAPs)conductedjointlybytheiMFandtheWorldbankaresupposedtocheckwhetherthecountriesarefollowingbaselrules.inaddition,thesuppositionisthatthedevelopingcountriesbelong-ingtotheG20–andthereforeautomaticallytotheFinancialStabilityboard18–shouldsetanexampletootherdevelopingcountriesbypromptlyapplyingwhatever is decided in those various committees,eveniftheydonotexerciseanyformalauthorityoncountries.

infact,inmanydevelopingcountriesthathaveexperiencedseriousbankingcrisessincethe1980s,capitalandliquidityrequirementshavebeenmuchhigherthanthoseprescribedbybaselrules(inwhatused tobecalledbasel+ rules).experience in theapplicationofthoserulesindicatesthattherewasa

generalized restriction on lending, in particular tosmallandmedium-sizedenterprises.

Therecentfinancialcrisishasalsoledtonewthinkingaboutthestructureofbanking.onemainfeatureoftheproposedreformsistheseparationofcommercialfrominvestmentbankingactivities.Theideaistoinsulateretailbankingthatisvitalforthenormal functioningof theeconomy(as it receivesdeposits and savings, delivers loans andmanagespaymentmechanisms)fromriskieractivitiesrelatedto securities trading (Gambacorta andVanRixtel,2013).inparticular,thenon-deposit-takingsidewillnothaveaccesstolender-of-last-resortfacilitiesfromthecentralbank.Hence,separatingbankingactivitiesmayalsohelptoimprovetransparencyinthefinancialsector,whichwouldfacilitatemarketdisciplineandsupervision, and – ultimately – support efforts torecoverfromthepresentcrisis,whilealsoreducingrisksoffurthercrises.

ongoingorproposedreformsarelessradicalthantheirnotoriouspredecessor,theGlass-SteagallAct,adoptedin1933inresponsetoanevenlargerbankingcrisis.intheUnitedStates,theVolckerRuleprohibitsproprietarytradingbybanksoperatinginthecountry,anditalsorestrictsprivateequityactiv-ity.However,althoughtherulebecamelawin2012,banksweregiventwoyearstocomply.intheUnitedKingdom, theVickersCommission recommendedplacingaring-fencearoundretailbankingactivities,separatingthemfromtheinvestmentbankingactivi-tiesoffinancialinstitutions.legislationisplannedfor2015,andbankswouldhaveuntil2019tocomply.ineurope,theliikanenplanwasannouncedinoctober2012,whichproposedthattheinvestmentbankingactivitiesofuniversalbanksbeplacedinaseparateentityfromotherbankingactivities,buttherearenoplansatpresenttolegislateontheseproposals.

Theneedtoseparatedifferentbankingactivitiesisalsocloselyrelatedtoconcernsaboutbanksize,inpar-ticularwiththeriseofverylargeuniversalbanksthatcoveranextremelybroadrangeoffinancialactivitiesinmanycountriesandjurisdictions.Hence,regulationseekinglegal,financialandoperationalseparationofdifferentbankingactivitieswouldhelp toavoid theeventualityofcertainfinancialinstitutionsgrowingsolargeandassumingsuchadiversityofactivitiesthattheirperformancebecomessystemicallyimportant(Viñalset al.,2013).Developingcountries,wherefinancial systemsare still in theprocessof taking

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shapeandwherethereisconsiderablescopeforanexpansionofcommercialbankingactivitiesmaybewelladvisedtodrawlessonsfromtheexperienceofthedevelopedcountriesinthisregard.

othermeasuresenvisagedindevelopedcoun-tries,especiallythoseaimedatimprovingbankinggovernance and resolution in case of bank failuremayalsobeofimportanceindevelopingcountries.Suchmeasures couldpossibly be easier to imple-ment incountrieswhosebankingsystemsare stillrelativelysmallbutmayexpandastheireconomiesgrow.An important objective in this context is toreduce incentives for highly risky behaviour ofmarketparticipantswhocanobtain largefinancialprofitswithouthavingtobeartheconsequencesofincurringlosses.Resolutionmechanismsmustallowauthorities towind down bad banks, recapitalizeinstitutionsthroughpublicownership,andforcethebail-in of creditors that have becomemuchmoreimportantthandepositorsinthefundingofsystemi-callyimportantinstitutions.Allthiswouldhelpreturnbankstoproductiveactivitiesasquicklyaspossible,withouthavingtouseenormousamountsofscarcepublicrevenueinbailoutoperations(borio,2012).19

insummary,thesedifferentcategoriesofregu-latory approaches reflect awelcomenewpoliticalwillingnesstograpplewithlong-standingissuesthatstandinthewayofsustainableeconomicrecovery.However, their “one sizefits all” approach is notnecessarilythemostappropriatefordevelopingcoun-tries.Amajorlimitationisthattheytendtonarrowlyfocusmoreonthestabilityofthefinancialsystemthanon its efficiency in termsof serving the realeconomy.Yetthislatteraspectisparticularlyimpor-tantfordevelopingcountries,muchmoresothanfordevelopedcountries.Muchstillremainstobedonetohelpaligntheincentivesofthefinancialsectormorecloselywiththeneedsofproductiveinvestment,jobcreationandsustainableeconomicgrowth.

3. Orientingthefinancialsectortowardsserving the real economy

inordertosupportdevelopmentstrategiesthatgiveagreaterroletodomesticdemandfordrivinggrowth, it is essential for developing countries tostrengthen their domesticfinancial systems.Theyneed to focuson thefinancial sector’skey role in

economicgrowth,which is thefinancingoffixedcapitalformationthatboostsproductionandgener-atesemployment.

inmostcountries,investmentsinrealproduc-tive capacity arefinancedprimarily from retainedprofits (internalfinancing)orby resorting tobankcredit(table3.3).Theobservationthatinternalfinanc-ingisthemainsourceforthefinancingofinvestmenthighlightstheimportanceofstrengtheningaprofit-investmentnexus.Thisisimportantnotonlybecauseofthedecisiveroleofrisingdemandformakingaddi-tionalinvestmentinproductivecapacityprofitable,asdiscussedinchapterii,butalsobecauseoftheneedtofinanceprivateinvestment.Thisrunscountertotheconventionalideathathigherhouseholdsavings,andthuslowerconsumption,arepreconditionsforgreaterinvestments.indeed,apolicythataimsatincreasingthosesavingsasameanstoraisingtherateofinvest-ment,ratherthanviewingsavingsasresultingfromhigherinvestment,weakensdemandandeconomicactivity,withanegativeimpactonprofits,whichareamajorsourceofinvestmentfinance.

Moreover,financingbybankscanenablefirmstoacceleratetheircapitalformationoverandabovewhatispossiblefromretainedprofits.Forpotentialinvestors toborrow for thispurpose,financingbybanksmustbeavailableinsufficientamountsandatacostthatiscommensuratewiththeexpectedprof-itabilityoftheinvestmentproject.Again,aimingatincreasingtheavailabilityoffinancingforinvestmentbyencouraginganincreaseinsavingsdepositsinthebankingsystemwouldbecounterproductive,becausehigherinterestratesalsomeanhighercostsofbankfinancingforpotentialinvestors,inadditiontothedemand-reducingeffectofhigherhouseholdsavings.

Therefore, a more promising approach toincreaseboththepropensitytoinvestandtheavail-ability of financial resources for investment is tosupport demand, encourage the reinvestment ofprofitsand facilitateaccess to long-term, low-costbankloans.Newloansdonotrequireanincreaseinsavingsdeposits;theycanbemadeavailablethroughthecentralbank’sprovisionofadequateliquiditytothebankingsystemandbykeepingthepolicyinterestrateaslowaspossible.

in developing countries, since the financialsystems aremainly bank-based, banking reformshouldbeapriority.Thefollowingsectiondescribes

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abroadrangeofbank-relatedpolicyinstrumentsandinstitutionswhichwould enable amore effectivedistributionofcreditthatsupportsrealgrowth.

(a) Measures for orienting bank financing to serve the real economy

Variousmeasurescouldbeconsideredforori-entingbankfinancingtosupporttherealeconomy.Tobeginwith,bankscouldbeencouraged,orobliged,toundertakeamorereasonableamountofmaturitytransformation operations (i.e. deliver long-termcreditsmatchedbyshort-termdeposits).inthepast,commercial banks in developing countries oftenpreferredtograntmainlyshort-termpersonalloansorbuygovernmentsecuritiesbecausetheyconsid-ered the risks involved inmaturity transformationtobetoohigh.However,theserisksmayhavebeenexaggerated, since, even during severe financialcrises,withdrawals of deposits frombanks neverexceeded25percentoftheirdepositbase.Arevisedregulatory framework could include elements thatencourageadifferentallocationofbankassetsandcreditportfolios,accompaniedbyrequirementsforprovisioningandforadequatecollateraltotakeintoaccount the additional risks related to the longermaturityofaproportionoftheirassets.Moreover,public guarantees for commercial bank credit forthefinancingofprivateinvestmentprojectsortheir

co-financingwithnationaldevelopmentbanksmayencouragebankstoprovidemorelendingforsuchpurposes.byreducingthecreditdefaultrisk,suchmeasureswould also lower the risk premiumsonsuchlong-terminvestmentloans.Theresultinglowerinterestcostforinvestorswouldfurtherreducetheprobabilityofdefaults,andthusreducethelikelihoodofgovernmentshavingtocoversuchlossesundertheguaranteescheme.

Centralbankscouldsupportmaturitytransfor-mationintheirroleaslendersoflastresort(llR)andbyprovidingdepositinsurance.Thelattermeas-urewould reduce the risk of suddenwithdrawalsofdepositsthatcouldresultinliquidityconstraintsforbanks,whiletheformerwouldaddressliquidityshortages,shouldtheyoccur.Thesearrangementsareofcoursenotnew:thellRprinciplewasproposedintheearlynineteenthcenturyandalsoadvocatedbybagehot in 1873,while deposit insurance hasbeen progressively implementedworldwide sincethe1930s.butsucharrangementshaveseldomsuc-ceededinencouragingbankstoprovideasignificantamountoflong-termfinancingtotherealeconomy.Amorehands-onapproachbythemonetaryauthoritiesisthereforerequired.

Historically, central banks have used awidevarietyofinstrumentstochannellong-termfinanceinsupportofdevelopmentobjectives(epstein,2005),

Table 3.3

SOURCES OF INVESTMENT FINANCE, SELECTED COUNTRy GROUPS, 2005–2012

Number of countries

Number of firms

Internal finance

Bank finance

Trade credit

Equity or stock sales

finance Other

(Per cent)

All countries 136 70 781 68.4 17.2 4.8 3.8 5.7

Developed Europe 5 3 354 57.7 20.5 3.3 4.9 13.6Emerging Europe 10 3 196 58.4 25.2 5.0 6.8 4.6Africa 44 17 971 81.1 9.4 3.4 1.5 4.5Latin America and the Caribbean 31 14 657 59.0 21.0 10.1 4.4 5.6Developing Asia 24 20 477 67.1 20.3 2.8 2.8 7.0Developing Oceania 5 619 53.3 25.8 3.2 9.0 8.7Transition economies 17 10 507 69.4 15.6 4.3 7.4 3.3

Source: UNCTAD secretariat calculations, based on World Bank, Enterprise Survey database.Note: Developed Europe comprises Germany, Greece, Ireland, Portugal and Spain. Emerging Europe comprises Bulgaria, Czech

Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia.

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including direct financing of non-financial firms.Forinstance,beforetheFirstWorldWarandintheinter-war period, thebank ofengland supporteddifferentindustrialsectors,includingtextiles,metal-lurgy,shipbuilding,aluminium,rayonandwood-pulpindustries.indeed,thebankbecameheavilyinvolvedin some industries, taking equity stakes and par-ticipating directly in theirmanagement. in 1929,theSecuritiesManagementTrustwasinstitutedasaholdingcompanyformanagingthestakesacquiredbythebankinvariousfirms.Similarly,thebankofitalygotinvolvedinthefinancingandindirectmanage-mentofdifferentindustrialfirms(o’Connell,2012).

Centralbankandgovernment intervention increditallocationbecamewidespreadintheimmedi-ate post-war period in developed and developingcountries alike. For example, France nationalizedthemaindepositbanksandestablishedtheNationalCreditCouncil,whichwas inchargeofallocatingcredit in accordancewith national interests andpriorities(Coupaye,1978).Creditpolicywaspartlyimplementedbyanumberofpublic,semi-publicandspecializedcooperativeinstitutions,whichfinancedagriculturalactivitiesandthedevelopmentofruralinfrastructure aswell as regional andmunicipalinvestments,socialhousingandindustrialandcom-mercial investments in small andmedium-sizedenterprises(SMes)atpreferentialrates.inaddition,France’scentralbank influenced the lendingdeci-sions of the commercial banks through selectiverediscounting at preferential rates, the conditionalreleaseofmandatoryreserves,andtheexemptionofcertainactivities(e.g.exportcredits,medium-termloansforinvestment)fromquantitativecreditceil-ings(encadrement du crédit)thatwereinplaceuntil1986,aswellasthroughamultitudeofcreditlinesforspecificusesatpreferentialrates.othereuropeancountries, includingbelgium,Germany, italy, theNetherlands and theUnitedKingdom, also usedsimilarinstruments,notonlytosupportsomesectorsandactivities,butalsotodiscouragecredit-financedpersonalconsumption,importsandinventoryaccu-mulation(Hodgman,1973;o’Connell,2012).

inseveralAsianandlatinAmericancountries,thepredominanceofbankcreditinfirms’debtfinanc-ingprovidedthebasisforproactivecreditpoliciesaimedatinfluencingtheallocationofbankcreditandmoderatingthecostsofinterest.Thesepoliciesplayedadecisiveroleinfosteringtheprocessofindustri-alization,especiallybetweenthe1950sand1980s.

Specializedinstitutions,includingnationaldevelop-mentbanksandotherState-ownedbanks,channelledlong-termcredittoselectedindustries,agricultureandhousing.Credit distributionby commercial banks,someofwhichwereState-owned,20wasalsosubjecttogovernmentpolicies,orcentralbankregulations.For instance, in indonesia,Malaysia, theRepublicofKorea,ThailandandTaiwanProvinceofChina,loans to SMes had to constitute a given share ofbanks’assets.inaddition,centralbanksintroduceddifferentialreserverequirements,rediscountingandaccesstocentralbankloansatregulatedinterestratesinorder toorientcreditallocation.Theseschemesplayedacentralroleintherapidindustrializationofmanycountries.However,theydidnotalwaysdelivertheexpectedoutcomes,andinseveralcountriestheyweremisused,asState-ownedbankssometimespro-videdcredittootherpublicentitiesforpurposesthatwerenotrelatedtoproductiveinvestment.Asaresult,non-performingloansburdenedtheirbalancesheetsandunderminedtheirlendingcapacities.ontheotherhand,itwastheprivatizationofState-ownedbanksandderegulationoffinancialsystemsthatpavedthewayformajorfinancialcrisesinlatinAmericaandeastandSouth-eastAsia.

inlightofthesedifferentexperiences,develop-ingcountriesneedtocarefullyweightheprosandconsofthedifferentsystemswhenshapingorreform-ingtheirdomesticfinancialsectors.Theyshouldalsoensurethatpublicandprivatefinancialactivitiesareundertakenbyinstitutionsequippedwithappropri-ategovernance structures and that theyoperate intheinterestsoftheeconomyandsocietyasawhole.

Atpresent,flawsincreditallocationbyderegu-latedprivatebanksanddifficultiesinreestablishingthesupplyofcreditfortherealsectorindevelopedeconomies(despiteexpansionarymonetarypolicies)haveledtoarenewedinterestincreditpolicies.Forinstance, inJuly2012thebankofenglandestab-lished a temporaryFunding forlendingScheme,with the goal of incentivizingbanks andbuildingsocietiestoboosttheirlendingtothecountry’srealeconomy.Underthisscheme,thebankofenglandprovideslow-costfundingtobanksforanextendedperiodof time,andboth thepriceandquantityoffundingprovidedarelinkedtotheirlendingperfor-mance(increasednetlendingtoSMes,forinstance,givesthemaccesstoagreateramountofcheapfund-ing) (bankofengland,2013).ThebankofJapanhadlaunchedasimilar initiativein2010(bankof

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Japan,2010).inthesamevein,severalinitiativesaimtoincreaselendingbypublicinstitutionstoSMes.Forinstance,theGermandevelopmentbank(KfWentwicklungsbank)istolend€1billiontotheSpanishdevelopment bank (instituto deCréditooficial,iCo),sothatitcanchannelloanstoSMesinSpainatGermanlendingrates.inaddition,inJune2013theeuropeanCouncillaunchedaninvestmentPlanwiththesupportoftheeuropeaninvestmentbank,whose capitalwas increased by €10 billion.TheplanenvisagestheprovisionofadditionalcredittoprovideSMeswithbetteraccesstofinanceandfosterjobcreation,especiallyfortheyoung(eib,2013).

However,theseinitiativesarefrequentlyintro-duced as extraordinarymeasures for dealingwithexceptionalcircumstances.Therearestrongargumentsinfavourofcentralbankandgovernmentinterventiontoinfluencetheallocationofcreditinnormaltimes,especiallyindevelopingcountries.Suchcreditshouldaimatstrengtheningthedomesticforcesofgrowthandreducingfinancialinstability,sincelong-termloansfor investmentand innovationandloans tomicro,smallandmedium-sizedenterprisesareextremelyscarce even in good times (TDR 2008, chap. iV).Somerecentreformshavesoughttoencouragethiskindof interventionby the central banks, therebyreinforcingorrestoringtheirhistoricaldevelopmentalrole.21inadditiontotheobjectivesofmonetaryandfinancialstability,centralbanksshouldcomplementothergovernmenteffortsandpoliciesaimedateco-nomicdevelopmentingeneral,withanemphasisonimprovingproductivityandgeneratingemployment.

Suchpolicieswouldmainlyinvolvecommer-cialbanksratherthaninvestmentbanks,aspartofa“socialcontract”betweentheformerandthecentralbank.Accordingtosuchacontract,thecentralbankwouldprovidedepositinsuranceandliquiditysup-portifneeded(asanllR),whilecommercialbankswould assume the taskofmaturity transformationfollowingguidelines by central banks, in additionto providing lines of credit under certain condi-tions.Thisisanadditionalreasonfordifferentiatingbetweendeposit-takinginstitutionsandinvestmentbankswhich intermediate between investorswill-ingtorunhigherrisksandnon-financialcompaniesdemandinglong-termfinance,andwhichwouldnothaveaccesstollRfacilitiesandliabilityinsurance.

Managingabankingsystemwithdevelopmentobjectives is not a purely technicalmatter; it also

involves political choices, and therefore calls intoquestion the rationale for keeping a central bankindependent of elected authorities. Strictly speak-ing,policyinterventionaimedatsecuringmonetaryandfinancialstabilityisalsopoliticalinnature,asillustratedbythewaythecrisiswasmanaged.intheprocess, central bankshad to distribute gains andlosses,redistributeincomeandwealth,decidefororagainst bailouts anddictate rescue conditions, notonlytoprivatefinancialandnon-financialagents,butalso,aswiththecountriesintheeuro-zoneperiphery,tosovereignStates.ifitisacceptedthatthemandateof central banks should be broadened to includedevelopmentobjectives,thepurelysupposedly“tech-nical”characteroftheiractivitiesbecomesevenmoreillusory.ifthemonetaryauthoritiesaretoimplementmonetary,financialandcreditpoliciesaspartofadevelopmentstrategy,theyneedtocoordinatetheiractionswiththeothereconomicauthorities.

(b) Towards more diversified financial systems

besides a growing awareness of the need toreviewtheroleofcentralbanksandthestructureofcommercialbanking,asdiscussedabove,thereisalsoarenewedinterestinthescopeandroleofdevelop-mentbanks.ThesetypicallyState-ownedbankscantakedeposits(althoughnotasmuchasnormalcom-mercialbanks), raise funds incapitalmarketsandprovideloansforprojectsthatareintendedtocontrib-utetooveralleconomicdevelopment.Historically,governments established development banks toprovidefinancialservicesthatprivatefinancialinsti-tutionswereunableorunwilling toprovide to theextentdesired.eventoday,despitedecadesofcriti-cismofthepublicsectorandawidespreadbeliefthatprivatizationofState-ownedinstitutionswouldaccel-erategrowthandraiseproductivity,alargenumberofdevelopmentbanksstillexist.About40percentofthesewereestablishedbetween1990and2011.Morerecently,newoneshavebeencreatedinanumberofdevelopingandemergingmarketeconomies,includ-inginAngola,bulgaria,india,omanandThailand.intheUnitedKingdom,abusinessbankisintheprocessofbeingestablished,aswellasanew“Greenbank”tofinanceenvironmentalprojects;inFranceadevelopmentbankwasrecentlycreatedandtherearealsoplansforanewdevelopmentbankintheUnitedStates.Thisindicatesthatgovernmentsstillconsidernationaldevelopmentbankstobeusefulinstitutions

Trade and Development Report, 2013136

forpromotingeconomicgrowthandstructuralchange(deluna-MartínezandVicente,2012).

State-ownedfinancialinstitutionsareestimatedtoaccountfor,onaverage,25percentofthetotalassetsoftheworldbankingsystemandfor30percentofthetotalfinancialsystemoftheeU.inlatinAmerica, 56 public development banks distribute$700billionayear–some10percentoftotalcredit–andholdassetsamounting to25percentof theregion’sGDP(iADb,2013).oneofthebenefitsofhavingasizeablealternativesourceofcreditcreationand intermediation became clear during the latestcrisis, as development banks played an importantcountercyclical role, increasing their lendingport-foliosjustasmanyprivatebankswerescalingbacktheirs.AccordingtoarecentWorldbanksurveyof90developmentbanksacrossdevelopedanddevel-oping countries, between late 2007 and late 2009thesebanksincreasedtheirloanportfoliosby36percentcomparedwithanincreaseofjust10percentbyprivatebanksoperatinginthesamecountries(deluna-MartínezandVicente,2012).

because they add diversity to the financialsystemandhaveabroaderrangeofobjectivesthantheprivatebankingsystem,developmentbanksmayalso be seen once again – alongsidemore activecentralbanks–asnormalcontributorstoahealthyandrobustfinancialsystemingoodtimesaswellasduringcrises.

Forpotentialentrepreneursseekingtopursuenewandinnovativeactivities,financingoptionsareparticularlyscarce,becausetheyconstituteacreditrisk that is especially difficult for ordinary bankstoevaluate.This iswhysmaller,morespecializedsourcesoffinancealsohaveanimportantroletoplayintheoveralldynamicsofthedevelopmentprocess.Typicalexamplesincludepubliclysponsoredincuba-torsthataremandatedtofinanceactivitieswhichhavethepotentialtoenhancediversificationandstructuralchangebutwouldnotnormallyhaveaccesstoprivatebankingsupport.Researchanddevelopment(R&D)activitiesorcreativeindustries,forexample,areoftenpubliclysupportedinmostdevelopedcountries.

othernon-bank-basedsolutionstotheproblemsofaccessingcredithavealsoemergedinrecentyears.Forexample,newformsoffinancehavedevelopedthroughthesocialmedia,suchascrowd-sourcingloansandpaymentmechanismsthatoperatethroughpeer-to-peernetworks.NetworkssuchastheNewYork-basedKickstarter,whichhaschannelledover$600milliontothousandsofprojectsoverthelastfouryears,ortheUnitedKingdom’slendingClub,suggestthatinnova-tivenewmechanismsareemergingwheretraditionalfinancialmarkets are failing to deliver.Certainly,therearemanyhistoricalexamplesof institutionalsolutions thatwere innovative once but are nowconsideredmainstream, such asworkplace-basedcreditunionsorcorporatestructuresofcooperatives.However,suchmodelswouldnotbeappropriateforallenterprises,andmustbeenseenaspartofadiverserangeofchoicesexistingwithinabroaderfinancialstructurethatservesavarietyofneeds.

Withinthisbroadargumentforamorediver-sifiedfinancial systemmadeupofmanydifferentbankingandfinancialinstitutionsofdifferentsizes,objectives andmandates, it is clear that today’sparadigmofuniversal banking involvingverybiginstitutions needs to be reconsidered.This is notonlybecauseof the “too-big-to-fail”problem,butalsobecause there isaneed to facilitateaccess tocreditforspecificneedsandtoprovidestabilitytothesystembynotallowingcloselycorrelatedportfoliosto spreadcontagion.even ifmuchof thedirectedcreditisstillchannelledthroughcommercialbanks(forinstance,underafundingforlendingscheme),aproactivepolicyfordirectingcredittoproductiveusesmayneedtoresorttoanetworkofspecializedinstitutions,includingcooperativeanddevelopmentbanks.building(orrestoring)suchafinancialstruc-tureclearlyexceedstheimmediateconcernofcreditscarcityintroubledtimes.inaddition,thedevelop-ment of a financial structure thatwould facilitatetheallocationofcredittotherealsectorandtopro-ductiveinvestmentwouldalsohelpavoidsomeofthenegativeeffectsofforeigncapitalflowsfeedingbubblesandconsumptionbooms.onthecontrary,theeconomywouldbeabletoprofitfromlong-termcapital inflowsbychannelling them to investmentprojectsthatrequireimportsofcapitalgoods.

Financing the Real Economy 137

The adjustment of productive capacities tochangesinthecompositionofaggregatedemandisnotjustamatterofreallocatingexistingresources;inmostdevelopingandtransitioneconomies,italsorequiresacceleratingthepaceofcapitalaccumulation.Thisnecessitatestheprovisionofreliableandlow-costfinancetoproducersforproductiveinvestmentthroughappropriatemonetaryandcreditpolicies,aswellasaccesstoexternalsourcesoffinance.

Whilemany developing countries have hadlimitedaccesstointernationalcapitalmarkets,oth-ershavebeenrecurrentlyaffectedbymassivecapitalinflowsfollowedbytheirsuddenstopsandreversals.Frequently, such inflows have not served to sup-port long-termgrowth andproductive investment.Moreover,theirsizeandvolatilityhaveoftentendedto createmacroeconomic andfinancial instability.Therefore, the extent towhichfinancial resourcescontributetogrowthandstructuralchangedependsontheircomposition,theirallocationamongdiffer-entgroupsofusers,andhowtheyareusedbytherecipients.

Thelatestfinancialcrisis, likepreviousones,hasshownthatunregulatedfinancialmarketshaveastrongpotentialtomisallocateresourcesandgenerateeconomicinstability.Sinceprivatecapitalflowsareinherentlyunstableandoftenunproductive, activeinterventionbyeconomicauthoritiesisindispensableforpreventingdestabilizingspeculationandforchan-nellingcredittoproductiveinvestment.Acautiousandselectiveapproachtowardscross-bordercapitalflows, includingpragmaticexchange-ratemanage-mentandcapital-accountmanagement,wouldreducethevulnerabilityofdevelopingandtransitionecono-mies toexternalfinancialshocksandhelppreventlendingboomsandbusts.Suchanapproachcould

alsoincludemeasuresaimedatusingforeigncapitalfordevelopment-enhancingpurposes,especiallyforfinancingimportsofessentialintermediateandcapi-talgoodsthatarenotyetproduceddomesticallyandthatcannotbefinancedbycurrentexportearnings.Thiscouldbeparticularlyimportantinmanyleastdevelopedcountrieswithaviewtoincreasingtheiroverallproductivityandeconomicdiversification.

Perhapsmoreimportantly,developingandtran-sitioneconomiesmustincreasinglyrelyondomesticsourcesoffinance.Asretainedprofitsconstitutethemostimportantsourceoffinanceforinvestmentinreal productive capacity, followedbybank credit,strengtheningtheprofit-investmentnexusandinflu-encingthebehaviourofthebankingsysteminthewayitallocatescreditareofparticularimportance.Themarketmechanismalonecannotberelieduponto achieve this; a variety of fiscal and regulatorymeasurescanalsobeused,asdemonstratedbymanysuccessfulindustrializingcountries.

Moreover,monetary policy alone is not suf-ficienttostimulateinvestment,asevidencedbythepolicy response to the ongoingfinancial and eco-nomicproblemsindevelopedcountries.Monetaryexpansionin thesecountrieshasfailedto increasebanklendingtoprivatefirmsforrevivinginvestmentinrealproductivecapacity.Thispointstotheneedforacreditpolicyaswell.Centralbankscouldsup-portmaturitytransformationinthebankingsystemand encourage, or oblige, banks to providemorelendingforthefinancingofproductiveinvestment.Thereisnothingradicallynewinsuchapolicy.Thereare numerous examples fromboth developed anddevelopingcountriesofcentralbankinvolvementinorientingcreditthrough,forexample,directfinanc-ingofnon-financialfirms,selectiverefinancingof

E. Summary and conclusions

Trade and Development Report, 2013138

commercialloansatpreferentialrates,andexempt-ingcertaintypesofbanklendingfromquantitativecreditceilings.

Creditpolicycanalsobepartlyimplementedbyotherpublic,semi-publicandcooperativeinstitutionsforfinancingagriculturalandindustrialinvestment,inparticularbySMes,atpreferentialrates.Nationalandregionaldevelopmentbanksmayprovideloansandfinancial services that private financial insti-tutions are unable or unwilling to provide.Moregenerally,anetworkofspecializeddomesticinstitu-tionsmaybemoreeffectiveinchannellingcreditfordevelopment-enhancingpurposesthanbiguniversalbanks.Thereisalsothedangerthatthesebanksmayeventuallyexpandtoanextentthattheybecomenot

only“toobigtofail”butalso“toobigtomanage”and“toobigtoregulate”.

Thus,forsupportingdevelopmentandstructuralchangewhatisneededisnotonlybetterregulationofthefinancialsystemaimedatachievingmonetaryandfinancialstability,butalsoarestructuringofthefinancial–particularlythebanking–systemtoensurethatitservestherealeconomybetterthaninthepast.Monetaryandfinancialstabilityandsustainedgrowtharecomplementarygoals:withoutthefirsttwo,sta-blegrowthof investment,outputandemploymentwouldbedifficulttoachieve,andwithoutsustainedgrowth,thereistheriskthatcorporatefailuresandnon-performingbankloanswillunderminemonetaryandfinancialstability.

Notes

1 Thetermemergingeconomies(oremergingmarketeconomies)referstoanumberofcountriestypicallybelongingtothemiddle-incomegroup,thatprivatefinancialinstitutionsconsidertobepotentialclients.Theyarealso seenasofferinghigherprofits thandevelopedeconomies,buttheyalsopresenthigherrisks.ThisgroupofcountriesincludesseveralnewentrantsintotheeUwhichpreviouslywereclassifiedastransitioneconomies.

2 This corresponds to the global stock of debt andequityoutstanding,asestimatedbylundetal.,2013.

3 Forinstance,anincreaseoftheexposureofUnitedStatesinstitutionalinvestors,suchaspensionfunds,toemergingmarketdebtfromthecurrentaverageof4percentto8percentoftheirportfolio(asrecom-mendedbysomeinvestmentadvisers)wouldfunnelintoemergingmarketbonds$2trillion,abouttwicethetotalamountofbondssoldbyemergingmarketcorporationsandsovereignStatesin2012–arecordyear(RodriguesandFoley,2013).

4 UNCTADsecretariat calculations, basedon iMF,Balance of Payments Statistics database andUNCTADstat.

5 These countries are:Afghanistan,burkinaFaso,burundi,Djibouti, theGambia,Grenada, thelaoPeople’sDemocraticRepublic,Maldives,SaoTomeandPrincipe, Saintlucia, SaintVincent and theGrenadines,Tajikistan,TongaandYemen.

6 Net capital inflows correspond to gross inflows(e.g. an increase of inward FDi or a new creditreceived)minusthereductionofforeignliabilities(forinstance,throughdisinvestmentofinwardFDiorthepayingbackofaforeignloan).itdoesnottakeintoconsiderationcapitaloutflows,suchasoutwardFDiorthegrantingofcredittoanon-resident.

7 UNCTADsecretariat calculations, basedon iMF,Balance of Payments Statistics database andUNCTADstat.

8 Suchabelief,popularizedattheendofthe1980sintheUnitedKingdombyNigellawson,thethenChancelloroftheexchequer(andoftenreferredtoas“lawson’slaw”),endedinthe“sterlingcrisis”in1992andthatcurrency’swithdrawalfromtheeRM.

9 The intermediation of the banking system alsoallowedtheeCbtocircumventitsstatutorylendinglimitsinfinancingitsmemberStates.Thiswasalso

Financing the Real Economy 139

convenientforthebanksthatcouldobtaineCbloansataninterestrateof1percentandacquiresovereignbondswithmuchhigherreturns.

10 DatafromtheeCb,euroAreaAccounts,Statistical Data Warehouse; availableat:http://www.ecb.int/stats/html/index.en.html.

11 Data from thebank for international Settlement,Consolidated Banking Statisticsdatabase.

12 inparticular,ifcentralbankssterilizemoneycreationresulting from the accumulation of internationalreservesbyincreasingtheirliabilities,afinancialcostarisesifinterestearningsfrominternationalreservesaresmallerthantheinterestpaymentsresultingfromthenewdebtissuances.

13 inthisrespect,therecentabilityofsomelDCstoaccessprivatecapitalmarketsshouldbeexercisedwith caution. Since 2007, several sub-SaharanAfricancountries,suchasAngola,theDemocraticRepublicoftheCongoandSenegal,haveissuedsov-ereignbonds.However,whilesuchforeign-currencydenominated government debt allows them someroomformanoeuvre,itcarriessignificantmaturityandcurrencyrisks,andmakesthosecountriesvul-nerabletothedestabilizingimpactofprivatecapitalmovements(StiglitzandRashid,2013).

14 ThecaseoftheArgentinean“ConvertibilityPlan”between1991and2001was,inthatsense,aharbin-gerforwhatishappeningtotheeuro-zoneperiphery.inArgentina,policymakerssoughtmonetarystabil-ityasthemainmacroeconomictargetbyadoptingacurrencyboardschemewithanirrevocablyfixedexchangerate.Atthesametime,theyderegulatedboththedomesticfinancialsystemandcapitalflows.Asexchange-rateriskseemedtohavedisappeared,capital inflows of the carry-trade type spurreddomestic credit and raised asset prices, leadingto some years of rapidGDPgrowth, although italsoledtoincreasingcurrentaccountdeficits.Thesubsequentlossofcompetitivenesseventuallyhurteconomicgrowthandmadethecountrydependentonever-increasingcapitalinflows.Anyslowdownofcapitalinflowsledtoeconomicrecession,asin1995and 1998–2001.After several years of economicdepressionandincreasingdifficultiesinmaintainingthe exchange-ratepeg, a reversal of capitalflowsledtothecollapseoftheConvertibilityPlan.TheGovernmenttriedtorestoretheconfidenceoffinan-cialmarketswithalawthatsoughttoeradicatefiscaldeficits(throughtheso-calledZero-deficitAct)byrequiringthatcurrentexpenditures(exceptinterestpayments)beadjustedquarterlytoexpectedfiscalrevenues.Thisledtoanacross-the-boardreductionof13percentinpublicservants’salariesandpen-sions, among other expenditures,which actuallyaggravatedtheeconomicdepressionand,asacon-sequence,alsoaffectedpublicrevenues.Meanwhile,thefiscaldeficitremainedstatic.Asdepositswere

increasinglywithdrawn frombanks and used forbuyingUnitedStatesdollars,theillusionthat“everypesoisbackedbyadollar”provedtobefalse,andthecurrencyboardhadtobeabandoned.Therefollowedahugedevaluationanddefaultof a largepropor-tionoftheexternaldebt.Thesetwounplannedandundesiredoutcomessetthefoundationsforeconomicrecovery,astheyrestoredcompetitivenessandledtodebtrestructuringandreduction.

15 ThistopichasbeenextensivelydiscussedinpreviousTDRs (see, for instance,TDR 2009,chap. iVandTDR 2011,chap.Vi).

16 inaddition,theiMFintroduceswhatamountstoakindofconditionalitybysubjectingthecountriesthatexercisetheirprerogativetointroducecapitalcon-trols(establishedinArticleVi,sec.3oftheArticlesofAgreements)tosurveillancedisciplines,asstatedinArticleiV.

17 Theproposalwasputforwardearlyinthereformula-tionprocess,buthasgainedstrengthaftertestsappliedby thebaselCommittee onbankingSupervisionshowedthatthereishugevariationbetweendifferentbanks’estimationsoftheirrisk-weightedassets,lead-ingtosignificant“savings”intheamountofcapitalrequiredtobesetasidetosupporttheiractivities.

18 Since2009,allG20membersarerepresentedonthebaselCommitteeonbankingSupervision(bCbS)andtheFinancialStabilityForum(FSF),andcon-sequentlyontheFinancialStabilityboard(FSb).

19 intheUnitedStates,theDodd-FrankActseekstoimposeabail-inofcreditors in theeventofbankfailureandpreventagovernmentbailoutofbanks.

20 Untilthe1980s,thebulkofdepositsandloanswasconcentrated in State-owned commercial banksin indonesia, theRepublic ofKorea andTaiwanProvinceofChina,andthesebanksstillplayamajorroleinChinaandindia.

21 Forexample,in2010,thecentralbankofbangladeshsetcommercialbanksatargetforloandisbursementstoSMesandwomenentrepreneurs,andthetargetissupportedbyarefinancingscheme.Achievementisaconditionfortheapprovalofnewbranchesoftheconcernedbank.inaddition,itrequiredallprivateandforeignbankstodirect2.5percentoftheirtotalloans to agriculture (bangladeshbank, 2013). inindia, theReservebankof india established that40percentofadjustednetbankcreditmustbetar-getedtothefollowingprioritysectors:agriculture,SMes,micro credit, education, housing, off-gridenergysolutions forhouseholdsandexportcredit(for foreign banks only) (Reservebank of india,2012).SeveralothercentralbanksinAsiancoun-tries,includingCambodia,China,Malaysia,Nepal,Pakistan andVietNam, direct credit to prioritysectors,areasorborrowers(typicallySMes),eitherbysetting lending targets tocommercialbanksorthroughrefinancingprogrammes(bhattacharayya,

Trade and Development Report, 2013140

2012).inlatinAmerica,mostcentralbanksaban-doned their developmentmandates in the 1990s,andfocusedoninflationtargets.However,apolicyreorientationseemstobeunderway.Forinstance,inMarch2012ArgentinareformeditsCentralbankCharter,which increased its ability to implementcredit policies.Under the new regulation, in July2012thecentralbankdeterminedthatallcommercialbanksmustlendtoproductiveinvestmentatmoder-ateinterestrates–atleasttheequivalentof5percentoftheirdeposits–andatleasthalfofthosecredits

mustbedirectedtoSMes.Thisschemecomplementsthe rediscount linewhichwasmade available tobanksthatfinancenewinvestmentprojectsunderthebicentennialFinancingforProductionprogrammelaunchedinJune2010.betweenJuly2012andMay2013, the credit granted through these two creditschemes accounted formore than 50 per cent ofthetotalcreditdeliveredtoprivatefirmsduringthisperiod(bCRA,2013).Thisshouldgraduallyreducebanks’strongbiasinfavourofshort-termfinancingandfacilitatingaccesstocreditbySMes.

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Chapter i CurrentTrendsandChallengesintheWorldeconomyChapter ii incomeinequality:TheMainissuesChapter iii evolutionofincomeinequality:DifferentTimePerspectivesandDimensionsChapter iV ChangesinGlobalizationandTechnologyandtheirimpactsonNationalincomeinequalityChapter V TheRoleofFiscalPolicyinincomeDistributionChapter Vi TheeconomicsandPoliticsofinequalityReconsidered

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trade and development report, 2009 UnitedNationspublication,salesno.e.09.ii.D.16Responding to the global crisis iSbN978-92-1-112776-8Climate change mitigation and development

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trade and development report, 2008 UnitedNationspublication,salesno.e.08.ii.D.21Commodity prices, capital flows and the financing of investment iSbN978-92-1-112752-2

Chapter i CurrentTrendsandissuesintheWorldeconomy AnnextabletochapteriChapter ii CommodityPriceHikesandinstabilityChapter iii internationalCapitalFlows,Current-AccountbalancesandDevelopmentFinance

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Chapter iV DomesticSourcesofFinanceandinvestmentinProductiveCapacityChapter V officialDevelopmentAssistancefortheMDGsandeconomicGrowth Annex: DetailsoneconometricStudiesChapter Vi CurrentissuesRelatedtotheexternalDebtofDevelopingCountries

trade and development report, 2007 UnitedNationspublication,salesno.e.07.ii.D.11Regional cooperation for development iSbN978-92-1-112721-8

Chapter i CurrentissuesintheWorldeconomy StatisticalannextochapteriChapter ii Globalization,RegionalizationandtheDevelopmentChallengeChapter iii The“NewRegionalism”andNorth-SouthTradeAgreementsChapter iV RegionalCooperationandTradeintegrationAmongDevelopingCountriesChapter V RegionalFinancialandMonetaryCooperation Annex1 TheSouthernAfricanDevelopmentCommunity Annex2 TheGulfCooperationCouncilChapterVi RegionalCooperationinTradelogistics,energyandindustrialPolicy

trade and development report, 2006 UnitedNationspublication,salesno.e.06.ii.D.6Global partnership and national policies for development iSbN92-1-112698-3

Chapter i GlobalimbalancesasaSystemicProblem Annex1: CommodityPricesandTermsofTrade Annex2: TheTheoreticalbackgroundtotheSaving/investmentDebateChapter ii evolvingDevelopmentStrategies–beyondtheMonterreyConsensusChapter iii ChangesandTrendsintheexternalenvironmentforDevelopment AnnextablestochapteriiiChapter iV MacroeconomicPolicyunderGlobalizationChapter V NationalPoliciesinSupportofProductiveDynamismChapterVi institutionalandGovernanceArrangementsSupportiveofeconomicDevelopment

Selected UNCTAD Publications 145

trade and development report, 2005 UnitedNationspublication,salesno.e.05.ii.D.13New features of global interdependence iSbN92-1-112673-8

Chapter i CurrentissuesintheWorldeconomyChapter ii incomeGrowthandShiftingTradePatternsinAsiaChapter iii evolutionintheTermsofTradeanditsimpactonDevelopingCountries Annex: DistributionofoilandMiningRent:SomeevidencefromlatinAmerica,1999–2004Chapter iV TowardsaNewFormofGlobalinterdependence

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trade and development report, 1981–2011 UnitedNationspublication,salesno.e.12.ii.D.5Three Decades of Thinking Development iSbN978-92-1-112845-1

Part One TradeandDevelopmentReport,1981–2011:ThreeDecadesofThinkingDevelopment 1. introduction 2. interdependence 3. Macroeconomicsandfinance 4. Globaleconomicgovernance 5. Developmentstrategies:assessmentsandrecommendations 6. outlook

Part Two PanelDiscussionon“ThinkingDevelopment:ThreeDecadesoftheTrade and Development Report”

openingstatement byAnthonyMothaeMaruping

originsandevolvingideasoftheTDR introductoryremarksbyRichardKozul-Wright StatementbyRubensRicupero StatementbyYιlmazAkyüz

TheTDRapproachtodevelopmentstrategies introductoryremarksbyTaffereTesfachew StatementbyJayatiGhosh StatementbyRolphvanderHoeven StatementbyFaizelismail

Themacroeconomicreasoninginthe TDR introductoryremarksbyCharlesGore StatementbyAnthonyP.Thirlwall StatementbyCarlosFortin StatementbyHeinerFlassbeck

evolvingissuesininternationaleconomicgovernance introductoryremarksbyAndrewCornford StatementbyJomoKwameSundaram StatementbyArturoo’Connell

Thewayforward ClosingremarksbyAlfredoCalcagno

Summaryofthedebate

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Trade and Development Report, 2013146

Thesepublicationsmaybeobtainedfrombookstoresanddistributorsthroughouttheworld.ConsultyourbookstoreorwritetoUnitedNationsPublications/SalesSection,PalaisdesNations,CH-1211Geneva10,Switzerland,fax:+41-22-917.0027,e-mail:unpubli@un.org;orUnitedNationsPublications,TwoUNPlaza,DC2-853,NewYork,NY10017,USA,telephone+1-212-963.8302or+1-800-253.9646,fax:+1-212-963.3489,e-mail:publications@un.org.internet:http://www.un.org/publications.

the financial and economic Crisis of 2008-2009 UnitedNationspublication,salesno.e.11.ii.D.11and developing Countries iSbN978-92-1-112818-5editedbySebastianDullien,DetlefJ.Kotte,AlejandroMárquezandJanPriewe

introductionthe Crisis – transmission, impact and special featuresJanPrieweWhat Went Wrong? Alternative Interpretations of the Global Financial CrisisDanielaMagalhãesPratesandMarcosAntonioMacedoCintraThe Emerging-market Economies in the Face of the Global Financial CrisisJörgMayerThe Financialization of Commodity Markets and Commodity Price VolatilitySebastianDullienRisk Factors in International Financial Crises: Early Lessons from the 2008-2009 Turmoil the Crisis – Country and regional studieslaikeYangandCorneliusHuizengaChina’s Economy in the Global Economic Crisis: Impact and Policy ResponsesAbhijitSenGuptaSustaining Growth in a Period of Global Downturn: The Case of IndiaAndréNassifBrazil and India in the Global Economic Crisis: Immediate Impacts and Economic Policy ResponsesPatrickN.osakweAfrica and the Global Financial and Economic Crisis: Impacts, Responses and Opportunitieslooking forward – policy agendaAlejandroMárquezThe Report of the Stiglitz Commission: A Summary and CommentRicardoFfrench-DavisReforming Macroeconomic Policies in Emerging Economies: From Procyclical to Countercyclical ApproachesJürgenZattlerA Possible New Role for Special Drawing Rights In and Beyond the Global Monetary SystemDetlefJ.KotteThe Financial and Economic Crisis and Global Economic Governance

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the global economic Crisis: UnitedNationspublication,salesno.e.09.ii.D.4systemic failures and multilateral remedies iSbN978-92-1-112765-2Report by the UNCTAD Secretariat Task Force on Systemic Issues and Economic Cooperation

Chapter i AcrisisforetoldChapter ii Financialregulation:fightingtoday’scrisistodayChapter iii ManagingthefinancializationofcommodityfuturestradingChapter iV exchangerateregimesandmonetarycooperationChapter V Towardsacoherentefforttoovercomethesystemiccrisis

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Selected UNCTAD Publications 147

regional monetary Cooperation and growth-enhancing policies: the new challenges for latin america and the CaribbeanUnitedNationspublication,UNCTAD/GDS/2010/1

Chapter i WhatWentWrong?AnAnalysisofGrowthandMacroeconomicPricesinlatinAmerica

Chapter ii RegionalMonetaryCooperationforGrowth-enhancingPolicies

Chapter iii RegionalPaymentSystemsandtheSUCReinitiative

Chapter iV PolicyConclusions

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price formation in financialized Commodity markets: the role of informationUnitedNationspublication,UNCTAD/GDS/2011/1

1. MotivationofthisStudy

2. PriceFormationinCommodityMarkets

3. RecentevolutionofPricesandFundamentals

4. FinancializationofCommodityPriceFormation

5. FieldSurvey

6. PolicyConsiderationsandRecommendations

7. Conclusions

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Thesepublicationsareavailableonthewebsiteat:http://unctad.org.CopiesmaybeobtainedfromthePublicationsAssistant,MacroeconomicandDevelopmentPoliciesbranch,DivisiononGlobalizationandDevelopmentStrategies,UnitedNationsConference onTrade andDevelopment (UNCTAD), Palais desNations,CH-1211Geneva 10,Switzerland;e-mail:gdsinfo@unctad.org.

Trade and Development Report, 2013148

UNCTAD Discussion Papersareavailableonthewebsiteat:http://unctad.org.CopiesofUNCTAD Discussion Papersmaybeobtained fromthePublicationsAssistant,MacroeconomicandDevelopmentPoliciesbranch,DivisiononGlobalizationandDevelopmentStrategies,UnitedNationsConferenceonTradeandDevelopment(UNCTAD),PalaisdesNations,CH-1211Geneva10,Switzerland;e-mail:gdsinfo@unctad.org.

unCtad discussion papers

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No.210 Dec.2012 GiovanniAndreaCoRNiA Developmentpoliciesandincomeinequalityinselected andbrunoMARToRANo developingregions,1980–2010No.209 Nov.2012 AlessandroMiSSAle Multilateralindexedloansanddebtsustainability andemanuelebACCHioCCHiNo.208 oct.2012 DavidbiCCHeTTi Thesynchronizedandlong-lastingstructuralchangeon andNicolasMAYSTRe commoditymarkets:evidencefromhighfrequencydataNo.207 July2012 AmeliaU.SANToS-PAUliNo Trade,incomedistributionandpovertyindeveloping

countries:AsurveyNo.206 Dec.2011 AndréNASSiF, Thelong-term“optimal”realexchangerateand CarmemFeiJó thecurrencyovervaluationtrendinopenemerging andelianeARAúJo economies:ThecaseofbrazilNo.205 Dec.2011 UlrichHoFFMANN Somereflectionsonclimatechange,greengrowth

illusionsanddevelopmentspaceNo.204 oct.2011 PeterboFiNGeR ThescopeforforeignexchangemarketinterventionsNo.203 Sep.2011 JavierliNDeNboiM, Shareoflabourcompensationandaggregatedemand DamiánKeNNeDY discussionstowardsagrowthstrategy andJuanM.GRAñANo.202 June2011 PilarFAJARNeS Anoverviewofmajorsourcesofdataandanalyses

relatingtophysicalfundamentalsininternationalcommoditymarkets

No.201 Feb.2011 UlrichHoFFMANN Assuringfoodsecurityindevelopingcountriesunderthechallengesofclimatechange:Keytradeanddevelopmentissuesofafundamentaltransformationofagriculture

No.200 Sep.2010 JörgMAYeR Globalrebalancing:effectsontradeflowsandemployment

No.199 June2010 UgoPANiZZA, internationalgovernmentdebt FedericoSTURZeNeGGeR andJerominZeTTelMeYeRNo.198 April2010 leeC.bUCHHeiT Responsiblesovereignlendingandborrowing G.MiTUGUlATiNo.197 March2010 Christopherl.GilbeRT Speculativeinfluencesoncommodityfuturesprices

2006–2008No.196 Nov.2009 MichaelHeRRMANN Foodsecurityandagriculturaldevelopmentintimesof

highcommoditypricesNo.195 oct.2009 JörgMAYeR Thegrowinginterdependencebetweenfinancialand

commoditymarketsNo.194 June2009 AndrewCoRNFoRD Statisticsforinternationaltradeinbankingservices:

Requirements,availabilityandprospectsNo.193 Jan.2009 SebastianDUllieN Centralbanking,financialinstitutionsandcredit

creationindevelopingcountriesNo.192 Nov.2008 enriqueCoSio-PASCAl Theemergingofamultilateralforumfordebt

restructuring:TheParisClubNo.191 oct.2008 JörgMAYeR Policyspace:What,forwhat,andwhere?No.190 oct.2008 MartinKNoll budgetsupport:Areformedapproachoroldwinein

newskins?

Selected UNCTAD Publications 149

G-24 Discussion Paper Seriesareavailableonthewebsiteat:http://unctad.org.CopiesofG-24 Discussion Paper SeriesmaybeobtainedfromthePublicationsAssistant,MacroeconomicandDevelopmentPoliciesbranch,DivisiononGlobalizationandDevelopmentStrategies,UnitedNationsConferenceonTradeandDevelopment(UNCTAD),PalaisdesNations,CH-1211Geneva10,Switzerland;e-mail:gdsinfo@unctad.org.

g-24 discussion paper seriesResearch papers for the Intergovernmental Group of Twenty-Four on International Monetary Affairs and Development

No.59 June2010 AndrewCoRNFoRD Revisingbasel2:TheimpactoftheFinancialCrisisandimplicationsforDevelopingCountries

No.58 May2010 KevinP.GAllAGHeR PolicySpacetoPreventandMitigateFinancialCrisesinTradeandinvestmentAgreements

No.57 December2009 FrankACKeRMAN FinancingtheClimateMitigationandAdaptationMeasuresinDevelopingCountries

No.56 June2009 AnuradhaMiTTAl The2008FoodPriceCrisis:RethinkingFoodSecurityPolicies

No.55 April2009 ericHelleiNeR TheContemporaryReformofGlobalFinancialGovernance:implicationsofandlessonsfromthePast

No.54 February2009 GeraldePSTeiN Post-warexperienceswithDevelopmentalCentralbanks:TheGood,thebadandtheHopeful

No.53 December2008 FrankACKeRMAN CarbonMarketsandbeyond:ThelimitedRoleofPricesandTaxesinClimateandDevelopmentPolicy

No.52 November2008 C.P.CHANDRASeKHAR GloballiquidityandFinancialFlowstoDevelopingCountries:NewTrendsinemergingMarketsandtheirimplications

No.51 September2008 UgoPANiZZA TheexternalDebtContentiousSixYearsaftertheMonterreyConsensus

No.50 July2008 StephanyGRiFFiTH-JoNeS enhancingtheRoleofRegionalDevelopmentbanks withDavidGRiFFiTH-JoNeS andDagmarHeRToVANo.49 December2007 DavidWooDWARD iMFVotingReform:Need,opportunityandoptionsNo.48 November2007 SamlAiRD AidforTrade:CoolAidorKool-AidNo.47 october2007 JanKReGel iMFContingencyFinancingforMiddle-income

CountrieswithAccesstoPrivateCapitalMarkets:AnAssessmentoftheProposaltoCreateaReserveAugmentationline

No.46 September2007 JoséMaríaFANelli RegionalArrangementstoSupportGrowthandMacro-PolicyCoordinationinMeRCoSUR

No.45 April2007 SheilaPAGe ThePotentialimpactoftheAidforTradeinitiativeNo.44 March2007 injooSoHN eastAsia’sCounterweightStrategy:AsianFinancial

CooperationandevolvinginternationalMonetaryorderNo.43 February2007 DeveshKAPURand beyondtheiMF RichardWebbNo.42 November2006 MushtaqH.KHAN GovernanceandAnti-CorruptionReformsinDevelop-

ingCountries:Policies,evidenceandWaysForwardNo.41 october2006 FernandoloReNZo iMFPoliciesforFinancialCrisesPreventionin andNelsonNoYA emergingMarketsNo.40 May2006 lucioSiMPSoN TheRoleoftheiMFinDebtRestructurings:lending

intoArrears,MoralHazardandSustainabilityConcernsNo.39 February2006 RicardoGoTTSCHAlK eastAsia’sGrowingDemandforPrimaryCommodities andDanielaPRATeS –MacroeconomicChallengesforlatinAmerica

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Trade and Development Report, 2013

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