Structural transformation for inclusive and sustained growth

Getting the world economy back on track requires that global leaders use bolder macroeconomic policies, strengthened regulation of finance and active industrial policies, the United Nations Conference on Trade and Development (UNCTAD) said on 21 September 2016.

In its annual Trade and Development Report, the United Nations body argues that economic slowdown in the advanced economies is the biggest drag on global growth, but developing countries are now caught in the downdraft.

“Policymakers all around the world face a difficult combination of sluggish investment, productivity slowdowns, stagnant trade, rising inequality and mounting levels of debt,” said UNCTAD Secretary-General Mukhisa Kituyi, adding that “solutions require an ambitious rethink, not a tepid business-as-usual reaction”.

A year of living dangerously

In many developed countries, a stringent fiscal stance and at times outright austerity have led to one of the weakest recoveries from an economic crisis on record. This has come on top of a prolonged period of slow wage growth, leading to insufficient household demand and weak spending on productive investment.

Growth in the United States of America is expected to slow to 1.6 percent this year, close to the Eurozone growth rate, while in Japan, growth continues to stagnate. In the United Kingdom of Great Britain and Northern Ireland, revived growth will be cut short by the decision by the United Kingdom of Great Britain and Northern Ireland to leave the European Union, or “Brexit”, though it is still difficult to predict just how big the impact will be, and what – if any – will be the wider contagion effects.

The loss of economic momentum in the advanced economies is having knock-on effects on developing countries, which will grow on average less than 4 per cent this year, some 2.5 percentage points below the pre-crisis figure. Considerable regional variations mean that while Latin America is in recession, Asia continues with slower but steadier growth.

Slower growth in developing economies compounds concerns for the global economy. In 2016, global growth will likely drop below the 2.5 per cent figure registered in 2014 and 2015, and UNCTAD economists would not be surprised if it dropped further.

Global trade has slowed even more dramatically following a brief bounce from the depths of the global financial crisis, dropping to just 1.5 per cent this year, a full percentage point lower than world output; the Geneva-based body argues that the lack of global demand and stagnant real wages are the main problems behind the slowdown in international trade. But if policymakers fail to mitigate the negative impacts of unchecked global market forces, then a turn to protectionism could trigger a vicious downward cycle affecting everyone.

Regulate finance: Money for nothing, but investment still stuck in low gear

“Enthusiasts for efficient markets once promised that financial deregulation would boost productive investment, but this promise has not been met,” said Richard Kozul-Wright, Head of the UNCTAD Division on Globalization and Development Strategies and lead author of the report.

“Instead, rising profits coincide with increased dividends, stock buybacks, and mergers and acquisitions, but not with new plant and equipment or even research and skill acquisition,” he said.

Corporations are not reinvesting their profits into production capacity, jobs, or self-sustaining growth. Indeed, even as profit shares have risen, private sector investment is over 3 percentage points lower than what it was 35 years ago, the report finds. It argues that a reliance on monetary policy and cheap credit to stimulate recovery has reinforced this pattern.

The UNCTAD report warns that developing countries have become increasingly vulnerable to volatile global financial markets, including speculative and sizeable capital flows, and that financial deregulation in emerging economies is beginning to see corporations reduce their profit-to-investment ratios, with negative consequences for long-term economic growth. In countries such as Brazil, Malaysia and Turkey, investment-to-profit ratios have fallen sharply since the mid-1990s, the report finds.

Net capital flows to developing countries turned negative in the second quarter of 2014, with over $650 billion leaving in 2015 and a further $185 billion in the first quarter of 2016.

The UNCTAD report warns that despite a respite in the second quarter of 2016, deflationary spirals remain a risk: capital flight, currency devaluations and collapsing asset prices could stymie growth and shrink government revenues. Several commodity exporters are already facing debt distress, and without more orderly workout procedures in place, worse could follow.

Alarm bells have been ringing, in particular, over the explosion of corporate debt levels in emerging economies, which now exceed $25 trillion.

The explosion of corporate debt has also coincided with the accumulation of financial assets and the skewing of investment towards highly cyclical and rent-based sectors of limited strategic importance for catching up, such as the oil and gas sector, mining, electricity, real estate and non-industrial services.

The report calls for the closure of corporate tax loopholes, plus fiscal and regulatory measures to encourage long-term investment. It argues for more diversified financial systems, including a bigger role for development banks.

Bolder macro policy: Boosting domestic demand is key to global growth

Advanced economies can help kick-start sustainable global growth by combining proactive fiscal policy, including on infrastructure spending, with supportive monetary policy and redistributive measures too, the UNCTAD report says. Redistributive policies include income policies, minimum wage legislation, progressive taxation and welfare-enhancing social programmes tailored to local circumstances. Such policies can also lead efforts to regulate against global and corporate financialization.

Developing countries should build domestic demand, use regulation to protect themselves from the risks of financialization in their domestic contexts and protect their policy and fiscal space to manage any unforeseen shocks, the report finds.

Many of these measures will require better policy coordination at the international level, particularly among systemically important economies in the Group of 20.

Manufacturing productivity growth in the South

According to the report, catching up is not getting any easier for developing countries. Some regions, notably East Asia, have successfully boosted productivity and incomes by developing strong manufacturing export sectors. But raising the share of manufacturing in gross domestic product above 30 per cent has not been replicated elsewhere, not even in their neighbours in the South-East, the report finds.

Elsewhere industrialization has stalled, with middle-income countries finding it increasingly difficult to move to the next level. In several cases, “premature deindustrialization” has taken place, often triggered by drastic policy changes that place undue faith in markets. In such cases, long periods of productivity stagnation or decline have coincided with declining shares of manufacturing value added and employment, and sharp falls in investment growth, particularly in the public sector.

In 2014, Asia alone accounted for 90 per cent of manufacturing exports from developing countries to the world and for 94 per cent of South-South trade in manufactures. Countries from East and South-East Asia in particular have been able to generate significant value added from their export of manufactures.

However, this model is looking less assured. Weak aggregate demand around the world has made export markets more crowded and competitive. Downward pressure on prices and wages has hit even the most successful Asian exporters. Job creation has stalled, notably among women.

Upgraded technology or economies of scale in selective industries can offer solutions. But the spread of global value chains, where a sector’s leading firms carry significant bargaining and pricing power, makes it challenging for developing country firms to enter markets in economically consequential ways, while any productivity increases drain abroad through lower prices.

Developing countries will need strategic policies to enhance their production, design and marketing capabilities in order to enter developed-country markets. Development-oriented competition policies and rules can also help nurture domestic producers. But global support to track sectoral trends in different segments of value chains and monitor restrictive business practices would also be helpful.

In addition, regional markets and South-South trade offer new export opportunities; however, a more balanced growth strategy would require attention to strengthening local markets.

UNCTAD contends that conventional policy advice on structural reforms, which often combine an overvalued currency and wage repression, will not contribute to deliver sustainable outcomes.

Industrial policy revived

The more challenging global environment means that developing countries cannot count on a swift return to the rapid growth enjoyed in the first years of the new millennium. Solutions will require ambitious but pragmatic responses, including a shift of resources towards more diversified and higher value added activities.

Industrial policy has always involved the selection and support of key sectors, but this year’s Trade and Development Report argues for a more sophisticated approach, including the construction of linkages and capabilities to build a production base fit for purpose in a rapidly changing world where sufficient space is available for experimenting and learning, both in the public and private sectors.

This is not only a matter for developing countries, with developed countries struggling to address post-industrial worries over secular stagnation and a hollowing out of the middle classes.

The report calls for policymakers to be more pragmatic, learning from both successes and failures.

Capable and stable government institutions, along with adequate public resources, matter. But dialogue between government and business is also essential for the exchange of information and building trust. Importantly, the state should also be willing and able to withdraw or withhold financial support in case of underperformance by business.

The report calls for a less ideological discussion of targeting support while also recognizing that standalone industrial policies are unlikely to deliver. Instead, the key to success lies in the effective integration of macroeconomic, financial, trade and industrial policies.