Economic growth in the time of disruption
Developing countries are facing major obstacles — many of which they have little to no control over — to achieving sustained high growth. Beyond the headwinds generated by slow growth of advanced economies and abnormal post-crisis monetary and financial conditions, there are the disruptive impacts of digital technology, which are set to erode developing economies’ comparative advantage in labor-intensive manufacturing. With the reversal of these trends out of the question, adaptation is the only option.
Robotics has already made significant inroads in electronics assembly, with sewing trades, traditionally many countries’ first entry point to the global trading system, likely to come next. As this trend continues, the imperative to build supply chains based on the location of relatively immobile and cost-effective labor will wane, with production moving closer to the final market. Adidas, for example, is already building a factory in Germany, where robots will produce athletic shoes, and is planning a second one in the US.
Given these facts, developing economies need to act now. First, the problems in advanced economies are likely to persist, reducing potential growth everywhere for an extended period. So developing countries must not try to boost demand through unsustainable means, such as the accumulation of excess debt. Instead, they, especially those in the earlier stages of economic development, must find new external markets for their goods, by maximizing trade opportunities with their counterparts in the developing world, many of which have considerable purchasing power.
Second, investment, both public and private, remains a powerful growth engine. In economies with excess productive capacity, targeted investment can yield a double benefit, generating short-term demand and boosting growth and productivity thereafter. Hence, shortfalls in investment that promises high social and private returns must be reduced, even eliminated.
Third, it is critical to manage the capital account in a way that protects and enhances the real economy’s growth potential. Large inflows of capital from economies with low interest rates can easily push up exchange rates, putting the tradable part of the economy under pressure. But the prospect of a capital-flow reversal adds risk, deters investment, and can produce sudden credit-tightening events.
In this context, selective capital controls and careful reserve management can help stabilize the balance of payments and ensure that the terms of trade do not change too fast to be offset by productivity growth.
Fourth, a realistic approach to the digital revolution is needed. Developing countries should recognize that disruption, despite happening fast, will not render their growth models obsolete overnight — China’s continued growth and rising household incomes are creating opportunities for lower-income economies in low-cost manufacturing. Yet developing countries must accept the inevitability of changes to their growth models caused by digital technologies and, instead of trying to resist them, they should be getting ahead of them, by embracing disruptive innovations. This means investing in the capacity — physical and human — to support their use, and preparing for the shift toward services that they will inevitably undergo as incomes rise.
Fifth, the distribution of gains from economic growth cannot be ignored. The advanced economies tried that with disastrous results: increasing political polarization, intensifying anti-establishment sentiment, declining policy coherence and weakening social cohesion. Developing countries cannot afford to make the same mistake.
Sixth, it is important to establish sustainable growth patterns early on. A “green” approach would not only stimulate additional growth; it is also likely to increase the quality of growth. Moreover, it will lead to a far more resilient economy in the long run.
Finally, entrepreneurial activity is vital to translate economic potential into reality. Policies that support such an activity, such as removing obstacles to new business creation and enhancing financing opportunities, cannot be left out of growth strategies. Opening channels for flows of information, ideas, expertise and talent from abroad can only enhance these efforts.
Developing economies may not have much control over the headwinds that they face today, but that does not mean they are powerless. Much can be done not just to sustain moderate growth, but also to secure a more prosperous and resilient future.