Look to the developing world

Riots, debts and the creeping fear of a looming Lost Decade – no wonder there is pessimism in Europe. But what we are seeing is not just “financial crisis, part two”; it is “sustainable growth challenge, part one”. The difference has implications for policy. Get the diagnosis wrong and the wrong treatment will follow.

The €750bn ($944bn, £652bn) package to defend the euro buys time. But it is not enough. So far, the world has focused on fiscal contraction and debt, but these are only half the story. The world and Europe also need a return to robust growth. Without it the fiscal adjustments will be more painful and the politics more unmanageable.

In the 1980s, when Latin America was overwhelmed by huge debts, the work-out involved rollovers of bank loans, fiscal tightening, funding from the International Monetary Fund and World Bank and policies to invigorate sustainable growth. Eventually, some debt was restructured. Some developed economies now face a similar problem: living beyond their means. But we face the added complication that weaknesses in parts of Europe can infect the European Union’s monetary, credit and even fiscal systems, with dangerous consequences.

To avoid a decade-long work-out – with political and economic risks – the world needs stronger growth in developing and developed countries. We are seeing a shift towards a new multi-polar global economy, with better prospects in developing countries than in developed ones. The World Bank projects growth in developing economies of about 6 per cent this year and next – more than twice that of high-income countries. Since 2000, developing countries have accounted for more than half the rise in global demand for imports.

This is not about winners taking all. An acceleration of this shift can help developed countries work out their problems while building a better-balanced global system. A dollar spent on investment goods in developing countries can yield 35 cents worth of demand for capital goods produced in high-income countries, precisely the kind of high-value goods that generate well-paying jobs.

Drawing on China’s experience in the late 1990s, some developing countries are boosting growth prospects through infrastructure to increase productivity. Countries throughout east and south Asia, Latin America and the Arab world are investing in transport, energy, water and urban centres, opening opportunities for sales of capital goods and services. They are experimenting with private capital and management in infrastructure, privatisation of assets and private sector delivery of public services.

Growth can be achieved through policy changes without government money. India’s remarkable growth since the 1990s has combined manufacturing gains with service sector reforms. A World Bank study of 4,000 Indian companies from 1993 to 2005 shows that reforms in banking, telecoms and transport raised manufacturing productivity. Policy changes in Africa encouraged the private sector to invest more than $60bn in technology, bringing 65 per cent of Africans in reach of wireless voice services.

Financial crises can spur reform. Last year as developed economies focused on Keynesian changes in demand, Asia-Pacific economies were advancing reforms – especially in services – to generate higher growth. As developed economies focused on financial regulation and a broader reregulatory movement, Asians were considering how deregulation might foster innovation and jobs.

Developing countries have understood that a sustainable recovery depends on reviving the private sector. Businesses will invest if the policy environment enables them to turn a profit. More governments implemented regulatory reforms to make it easier to do business in 2009 than in any year since 2004, with nearly 300 reforms registered worldwide. Most occurred in developing economies.

In “sustainable growth challenge, part one”, it is not about unmitigated austerity, but finding sustainable paths to prosperity. The EU and developed countries elsewhere need more than fiscal stringency, especially if achieved by piling on more taxes. They need to seize opportunities from growth in developing countries to avoid their own lost decade. There is a broader lesson: in 2008, the crisis was US-led; in 2010, it is European. For both the US and Europe, it is developing countries that point to the way ahead. It is time we took note.

The writer is the World Bank president

Copyright The Financial Times Limited 2010.

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