Tue, Nov 14, 2006 page9

• Sustainable globalization is all about minding the gap

  • By Jose Antonio Ocampo
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  Within today's booming world economy, most developing countries have been growing rapidly. Yet this has not diminished the pressure to reduce the yawning gap in income between developed and developing countries that has shaped global debates for more than 50 years.

  International inequalities, while large three decades ago, have worsened ever since. The most disturbing feature of this trend is the high number of "growth collapses" during the last decades of the 20th century, with only a few developing economies (East Asia, India) able to sustain high growth rates.

  But there is another international income divergence that demands attention. Since 1980, the world has witnessed a widening income gap among developing countries. As underscored by a recent UN report, World Economic and Social Survey 2006, this "dual divergence" holds four key lessons for economic growth in the developing world.

  First, success and failure in achieving sustained economic growth appear to be concentrated in time and space. This means that the growth of individual developing countries depends not only on their domestic economic policies -- the focus of debates on economic development in recent decades. It also depends on factors beyond the control of individual countries: global economic conditions and regional economic environments. Indeed, the recent boom in some parts of the developing world shows exactly that.

  Second, while pushing the technological frontier is the crucial element of growth in industrial countries, what matters for developing countries is transforming production and export structures, particularly by shifting resources to activities with higher levels of productivity. The key to achieving this is the capacity to diversify domestic production by generating new activities, strengthening economic linkages within the country, and creating new domestic technological capabilities.

  Building industrial and modern service sectors is critical for successful diversification. Conversely, de-industrialization and concentration of growth in informal service activities is a proven recipe for failure, as has been demonstrated by the sad experiences of most developing countries in recent decades.

  The form of integration into world markets also plays a central role in economic diversification. Countries that integrate into dynamic world markets for manufactures and services perform better than those that specialize in natural-resource intensive sectors.

  But exports are not the only key factor: even more important are the export sector's links with other domestic sectors. Pure extraction of mineral resources, as well as maquila-type manufacturing -- common in Mexico and Central America -- generate little additional demand for domestic industries and thus have only limited growth effects. A successful export strategy hinges not on how much countries export, but on what they export and how their export sectors are integrated with other domestic economic activities.

  The same is true of foreign direct investment (FDI). Countries that benefit most from FDI are those whose domestic firms and institutions also benefit, and thus those that have the requisite absorptive capacity.

  Third, macroeconomic stability, investment and growth are mutually reinforcing. But maintaining stability involves not only keeping inflation low, but also, and crucially, avoiding large swings in economic activity, external imbalances and financial crises. This explains why, in a world where developing countries are faced with increasing shocks, macroeconomic policies aimed at smoothing the business cycle (that is, counter-cyclical macroeconomic policies) play a vital role in economic growth.

  In recent decades, however, macroeconomic policy in most developing countries has become more pro-cyclical, largely exacerbating the volatility of international financial markets and commodity prices. Pro-cyclical fiscal adjustment tends to encourage a short-term orientation towards economic policy, which limits long-term investments in infrastructure and human capital, thus constraining growth.

  Fiscal space can be created by improving governance and strengthening the tax base, and, for the poorest countries, by achieving additional stable official development assistance (ODA) channeled through national budgets. Indeed, when ODA is not determined by geopolitics, it can have a strong positive effect on long-term growth, essentially because it supports investment in infrastructure and human development.

  Finally, institutional reform encompasses more than creating markets and guaranteeing property rights. It also includes creating the regulatory and institutional framework that markets require to function well, providing necessary public goods and guaranteeing the fairness of rules. "Big bangs" in institutional reform, however, may generate more harm than good. Minor and gradual institutional change can have a powerful impact on growth if it is perceived as initiating further credible reform.

  So what will it take to start closing international income gaps without damaging development prospects globally? We need to maintain a stable, growing world economy with international trade rules that are truly development-oriented -- the great expectation of the current (but so far frustrated) trade negotiations. This should be matched by the creation of "supply capacities" in developing countries, which requires production and trade sector policies that encourage structural transformation.

  We must also open up more space for counter-cyclical macroeconomic policies, approaching price stability less as an objective in itself than as an intermediate goal on the path to economic growth and employment creation. We need to ensure sustained levels of public spending to make the necessary investments in infrastructure and human capital, and to increase ODA channeled through the budgets of poor countries.

  Last but not least, we should promote gradual, home-made and country-specific institutional reforms.

  By pursuing an aggressive, yet flexible, agenda for domestic development, facilitated by international cooperation and rules that guarantee the appropriate "policy space" for developing countries, we can reduce global income inequality. If we mind the gap, we can make the leap to a better, more inclusive form of globalization.

  Jose Antonio Ocampo is UN under-secretary-general for economic and social affairs. Copyright: Project Syndicate
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