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The current world economic situation, the outlook for the coming decade and implications for LDCS.

1. LDC PROSPECTS IN THE CHANGING GEOGRAPHY OF THE WORLD ECONOMY

Since the onset of the new millennium, the global economy has witnessed the emergence of strong and sustainable growth poles in the South, and the intensification of South--South economic linkages through trade, capital, technology and labor flows (UNCTAD, 2011d). Such a rise of the South, as it is sometimes referred to, has resulted in shifts of balance in the world economy. These economic and geostrategic changes in the world economy during the 2000s were characterized by OECD (2010) as "shifting wealth". The main argument is that the centre of gravity of the world economy is shifting to the East, namely to Asia. Given the substantial difference in the rate of economic growth recorded after the 2008--2009 crisis, China and other dynamic economies like India, Brazil, South Africa and the Russian Federation, would continue to narrow the gap with advanced economies even faster than in the previous decade. The recent news that China has become the world's second largest economy is symbolic of the depth and significance of these shifts.

These changes, however, are not confined to the above-mentioned economies. For example, the GDP of the seven largest developing economies, adjusted for purchasing power parities, grew from 10.5 per cent of the GDP of OECD countries in 1980 to 21 per cent in 2010. Although the common perception is that the surge of Southern growth poles is largely an Asian phenomenon, Africa, Latin America and Western Asia also managed to expand their share of global output in the last 10 years. Similarly, a growing number of developing countries have been catching up with advanced economies, thanks to their faster GDP growth rates (OECD, 2010).

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This tendency has become even stronger in the aftermath of the global recession because developed and transition economies suffered deeper contractions of GDP during the 2008--2009 period, and their recovery is still uneven and extremely fragile, unlike that of a number of developing countries. The latest available forecasts at the time of writing (IMF, 2011) suggest that the South, particularly the Asian economies, is likely to increase its importance in the future (chart 8). There is every indication that the South's importance in the world economy will continue increasing in the foreseeable future.

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The shifting balance in the global economy has been mirrored in the growing importance of the South in world trade and investment flows (UNCTAD, 2011f; OECD, 2010). In the last two decades, other developing economies, not including LDCs, have succeeded in increasing their shares of global merchandise imports and exports, as well as strengthening their role as a source of outward FDI (chart 9). South--South trade grew, on average, 12 per cent per year from 1996 to 2009, that is, 50 per cent faster than North--South trade. In 2010, the share of developing and transition economies in the world's total FDI has for the first time reached that of developed economies (UNCTAD, 2011f). The intensification of South-South trade and investment flows is thus a fairly broad-based trend that has rendered the world economy considerably more interdependent.

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These processes are already exerting far-reaching effects on the world economy in terms of the economic size of national economies, economic growth and global demand patterns, and incomes and demographic trends. If the current trends continue, these effects will be even stronger in the future. Most importantly, they will likely result in significant breakdowns of the dominant position of the United States of America. Long-entrenched features of the economic, political and even ideological landscape will likely be further disrupted and reconfigured in the process. This is also an opportunity for the LDCs to reassess their national development strategies, rethink their global alliances and reposition themselves in the evolving international division of labor.

Given that the world economy is now much more complex, more integrated and more interdependent than ever before, a more developed and encompassing global economic governance regime is required in order to ensure its smooth functioning. However, the current governance regime has been formed under the assumption of the efficient-market hypothesis. As such, it lacks the appropriate institutions and mechanisms to regulate international financial flows and manage global macroeconomic imbalances.

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And yet, the new world order that is slowly, but inexorably emerging, will require much more global macroeconomic coordination, that goes beyond the recent efforts by the Group of Twenty, to avoid a repetition of the Great Depression that occurred between the two world wars. Alternatives to the present world order, as well as the new institutions that would have to accompany it, will remain less than fully defined and will take time to develop and become consolidated.

The crisis continues to affect the world economy

During the financial crisis of 2008--2009 and the resulting global recession, fiscal and monetary policies and instruments, including unorthodox ones such as quantitative easing, were widely used in many countries to support economic activity and to reduce or eliminate disruptions affecting the financial and real sectors. A repetition of a widespread dislocation of economic activity similar to the one that occurred during the Great Depression of the 1930s was successfully averted. However, one of the legacies of these policies is a partial substitution of private-sector indebtedness by public-sector indebtedness. In effect, public sectors have taken on the bad debts, most notably of banks, but also of other sectors. While this has relieved the pressure of the excessive indebtedness from the private sector, the burden has merely been shifted to the public sector.

The socialization of private losses, coupled with the effects of automatic fiscal stabilizers--higher expenditures and lower tax receipts during the crisis--has resulted in a swelling of public-sector debts in the developed economies. Public deficits close to 10 percentage points of GDP in the United States and the United Kingdom in 2010, for example, will result in rapid increases of the ratio of public debt to GDP. UN-DESA (2011) estimates that the average public debt ratio for developed countries will surpass 100 per cent of GDP in 2011. Therefore, while the global recession in a technical sense is over, the crisis itself is continuing in a different form as a sovereign debt crisis.

Turning to the advanced economies at large, the short-term economic outlook is hobbled by problems in all four components of aggregate demand. The de-leveraging process of the private sector (reduction of debt levels) in these countries triggered by the financial crisis is still under way. The post-recession period in most advanced economies is characterized by weak wage growth, persistently high unemployment and continuous weakness of the real estate sector. Consumption, the most important element of aggregate demand, will thus remain sluggish for several years, as consumers cannot pay off their debts and increase consumption at the same time. Investment in developed economies will likely underperform in the medium term, since there is still some unutilized capacity available and the final demand is weak.

In 2009 and 2010, government spending provided much-needed support for economic activity in developed and developing countries alike. However, as these measures resulted in a substantial deterioration of fiscal accounts in the former, their fiscal policy has now changed towards a more conservative stance. Most plans to reduce fiscal deficits rely heavily on cuts in fiscal expenditure. Thus, the economic austerity of the public sector in the developed countries is going to further subtract from the aggregate demand for a prolonged period (UNCTAD, 2011 e). The fourth component of aggregate demand is net export (exports minus imports). The weakness of other components of the aggregate demand in developed economies suggests that there would be increased pressure to use exports as a means to make economic activity more dynamic. However, it is a fallacy of composition to think that all developed economies could substantially increase their exports at the same time, as there is currently no effective demand for them. Summing up the four components of aggregate demand, it is clear that developed economies will not provide the needed level of aggregate demand for the world economy to grow faster.

The sluggish, erratic and jobless recovery in the advanced economies continues to have adverse effects on the LDCs. Moreover, since it is likely that the economic activity of the developed countries would remain below the potential growth rate for some time, the demand for imports from the LDCs-will be sluggish. As a result, the potential for export-led growth in the LDCs will be diminished, it is important to emphasize that the LDCs have a trade surplus with developed countries and a trade deficit with developing countries (see chapter 2). The two-track world economy will thus tend to deteriorate the trade balance of the LDCs, since the countries with which LDCs have trade surplus are likely to underperform.

In addition, the sovereign debt crisis will most probably hinder investment in productive capacities and put a cap on the future growth of the world economy--and of the LDCs in particular--by biasing investment decisions away from long-term, productive capacity-enhancing projects towards short-term, quick-profit ones. Given the dependence of the LDCs on external sources of financing, this could particularly hurt their prospects for the decade. Data concerning global FDI flows, for example, show that in 2010 flows amounted to only $1.24 trillion, nearly 37 per cent below the pre-crisis peak (UNCTAD, 2011f).

Another adverse channel may be ODA for LDCs. Traditional donors are' already beginning to reduce fiscal expenditure, which means they might not be able to continue to provide ODA at previous levels. It is likely that ODA will be reduced as the pressure to contain fiscal expenditure in developed countries intensifies further. The LDCs should, therefore, seek alternative sources of financing, including, but not limited to, official finance from other developing countries, and strengthen the domestic mobilization of resources.

In the medium term--three to five years--a rebalancing of the world economy will be needed. The pre-crisis world economy can be portrayed in a simplified manner as one in which the United States functioned as the consumer of last resort for the world. Africa and Latin America produced and exported commodities, Asia manufactured final consumption goods and the European Union and the United States produced capital goods. That arrangement resulted in increasing levels of private indebtedness in the United States, and to a lesser extent in the European Union, and is now seriously undermined.

A rebalancing of the world economy could provide a way out of the current malaise. However, it would require substantial changes in both the surplus and deficit economies. In surplus economies, it will require a substantial increase in wages (Germany, Japan and China) and in social redistribution schemes (China). These changes will take time, as it is possible to carry them out only gradually. Moreover, even if China, for example, succeeds in introducing the necessary changes fairly quickly, the impact of this additional demand on overall global demand would be relatively small, since today the Chinese economy is equivalent to only one third of the size of the United States economy. In deficit countries, rebalancing would require structural reforms to increase their competitiveness, accompanied by expenditure-switching policies and a reduction in overall-indebtedness. Again, it is unlikely that these changes can be implemented rapidly. Thus, the rebalancing of the world economy is likely to be a protracted process that would have to rely on politically difficult structural reforms.

Some studies indicate that the impact of the rebalancing on the LDCs could be negative. Mayer (2011) estimated the impact of rebalancing on trade and employment in the LDCs, concluding that the world exports would decline or grow less than before, with the largest impact on exports of industrial goods. Another global result would be a sizeable adverse impact on employment worldwide. Both effects might especially affect LDCs specializing in labor-intensive manufactures, while commodity-exporting LDCs would not be affected as much. In addition, the trade balance of most LDCs would most likely deteriorate.

The rebalancing of some of the large developing economies, in particular China, from exports towards domestic consumption may have a negative effect on the exports of developing countries into these regions. For example, a recent study (Akyuz, 2010) estimated that the import intensity of Chinese exports is in the range of 40--50 per cent. In contrast, the import intensity of the investment is only 15--20 per cent, while that of consumption is less than 10 per cent. This means that a rebalancing of the Chinese economy may decrease Chinese imports by a substantial amount. This, in turn, may have adverse effects on the exports of developing countries, including the LDCs, who have been increasingly reorienting their trade to China and more broadly to the South (see chapter 2 for more details).

The rebalancing of the world economy could also have positive effects on the LDCs. If a universal social safety net is established and wages are increased in China, one of the results would be a more costly labor input, which will make Chinese production more expensive. That, in turn, could be beneficial for LDCs, mostly characterized by very low labor costs. Conceivably, parts of the manufacturing industries from China would then seek to relocate to some LDCs, given the increase in labor costs at home.

The ongoing analysis suggests that the world economy will be fragile and unstable, as well as hobbled by a two-speed recovery in the coming years. It is also likely that the rebalancing of the global economy will only be partial in the next several years. Various sources also suggest that international trade will remain depressed for some time (IMF, 2011; UN-DESA, 2011). Thus, the outlook for the world economy is not positive and is surrounded by great uncertainty. Needless to say, the primary responsibility to drive recovery, revitalize growth and rebalance the world economy in a more inclusive and sustainable direction, lies with the advanced economies.

This more complex and challenging economic environment will put strains on policymakers in the LDCs, as many of the effects will be negative for their economies. With a more subdued demand for their LDC goods and services in developed countries, LDCs would have to seek opportunities elsewhere.

Large and dynamic developing countries, such as China, India, Brazil and South Africa, could be a priority in that reorientation. Likewise, regional partners, both within and beyond formal integration groupings, could prove to be additional outlets for LDC exports
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Title Annotation:Least Developed Countries
Comment:The current world economic situation, the outlook for the coming decade and implications for LDCS.(Least Developed Countries)
Publication:Economic Review
Geographic Code:9CHIN
Date:Jan 1, 2012
Words:2396
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