Emerged Economies

http://www.foreignpolicy.com/articles/2010/11/10/emerged_economies

Emerged Economies In the post-recession era, developing countries have come out on top. And they're going to stay there. BY OTAVIANO CANUTO, MARCELO GIUGALE | NOVEMBER 10, 2010

This week's G-20 summit, which begins today in Seoul, will have to acknowledge that the old conventional wisdom no longer holds true -- in the post-recession era, developing countries will steer the global economy, while the developed world takes the economic back seat. It's a major shift in the world's balance of economic power, and managing it is going to demand some deft policy moves from countries not known for their technocratic prowess.

The rise of the rest is not likely to be a temporary blip, a product only of the financial crisis. We are in fact at a major historical inflection point. Five long-term trends explain why. First, over the last decade, emerging economies have generally put their balance sheets in order. This will make them magnets for some of the new, massive savings that advanced economies will be forced to accumulate. But whereas the massive southbound capital flows of the early 1980s precipitated a series of debt crises, this time the money won't go to bankrolling bloated fiscal deficits in emerging economies. Governments in many of these countries are sitting on surpluses, after all. Instead, the money will pay for productivity-enhancing infrastructure investments, much of it initiated by private companies. Second, it's becoming cheaper for emerging economies to acquire, adapt, and adopt industrial technologies. These countries can now enter the industrial supply chain, if at a relatively lower rung. Take cars: For now, Japan makes the "electronically controlled, continuously variable transmission," China stamps the steel, while Vietnam makes the tires, and all countries benefit. Third, the new middle classes of the emerging economies are teeming. China's grew by 400 million in the past 30 years. Soon Brazil's and India's middle classes will match that rate of exponential growth. This won't just be about larger demand for TVs, cars, and apartments. As is already happening in many Latin American countries, it will also shift the political game toward the center, limiting the risk of sudden changes in policy course. Fourth, emerging economies are increasingly seeking to trade with one another. A free trade agreement with the United States or Europe is no longer seen as a sure-shot ticket to faster development. You also need entry into China, India, and other up-and-coming markets. South-south trade is powering new economies of scale and scope. And, fifth, natural resources have finally proved themselves to be more blessing than curse: Professional central bankers and more stringent independent watchdogs are ensuring that the influx of money isn't feeding government corruption or otherwise going to waste. NGOs are helping to ensure that the environment isn't sacrificed in the search for more natural resources.

Meanwhile, G-7 countries face a horizon of high unemployment, depleted house values, timid consumers, heavy public debt, stagnant growth, limited international coordination, and almost no policy levers left to pull. So while advanced economies are in a state of quasi-terminal lethargy, the developing world has been given a shot of adrenaline. But it's an open question what they'll make of it. The old playbook no longer applies: Policymakers in emerging economies will have to develop and pursue a new economic orthodoxy. No longer can they take their cues from their colleagues in the so-called First World. Imagine, for instance, that you are a finance minister in a developing country. While your peers in London, Paris, and Washington desperately need more revenue and less expenditure, your country probably came out of the crisis with a relatively strong fiscal position, especially if it is commodityrich. They worry about the pain they are causing with austerity; you worry how to use your plentiful cash. Their priority is quantity; yours is quality. Slowly but surely, developing countries are learning to save for hard times by putting in place smart, countercyclical policies. Politicians have finally converted into true believers. Leaders are learning that their popularity soars if they save enough money during good times to spend it when things go south. (Chile's former president, Michelle Bachelet, is the prime example of this: She dramatically turned around her declining approval rating by cushioning the initial impact of global economic turmoil with funds accumulated previously.) Free trade orthodoxy has also been turned on its head. The 2008-2009 crisis proved that free markets are more volatile than once thought. In two years, the volume of world trade fell by a third. International production networks carried the recession contagion at staggering speed from country to country. Naturally, calls for assertive trade policy have since gotten louder. The question is: What kind of intervention will it be? Public policy will, in most developing countries, take an enlightened path. Call it "export-led growth 2.0." A giant premium will be put on diversification, not only of partners but also of products, as an insurance against volatility. "Innovation" will be the new buzzword in global trade. To maintain the sustainability of their export-led growth models, emerging economies

will push internal reforms that promote new industries, including incentives from research and development to increased investments in higher education. Poverty-reduction policies demand the most change in the years ahead. There is a budding consensus -- amply corroborated by the crisis -- on what reduces poverty: fast and sustained growth (more jobs), stable consumer prices (no inflation), and targeted redistribution (subsidies only to the poor). Poverty fighters in the developing world will focus on all three, but most of all on providing for better jobs. Not just any jobs will do: What matters in reducing poverty is not just the number of jobs, but their productivity. This, of course, points toward a broader agenda of reforms to make their economies more competitive. Developing countries are also experimenting with more finely tuned social programs. Over the last 10 years, 30 developing countries have set up mechanisms to transfer cash directly to the poor via their cell phones. They now know their poor by name. This kind of state-citizen relationship proved a blessing to cushion the impact of the global crisis -- forestalling social unrest in Mexico, for example. It will also continue to make social expenditures more efficient, with smarter design and less duplication. In sum, if they further develop these sensible, new policies, many developing countries will break out of their "developing" status entirely. Such hopes should be tempered, though. Before the Great Recession, the developed world -- as well as the economics profession -- was confident it had laid a permanent foundation for never-ending prosperity. Now, those countries will have to depend on the developing world to pull them out of crisis. That's a smart strategy for now, but what works today will not necessarily work tomorrow.

Save big when you subscribe to FP. Otaviano Canuto is the World Bank's vice president for poverty reduction and economic management, and Marcelo Giugale is the World Bank's director of poverty reduction and economic management for Latin America and the Caribbean region. This article is based on the authors' recently published book The Day After Tomorrow: A Handbook on the Future of Economic Policy in the Developing World.