Global Policy Forum

Reducing International Inequality-

South Centre
July 2006

The World Economic and Social Survey 2006 just published by the United Nations focuses on ‘Diverging Growth and Development.' The report explains the growing income disparity between the industrialised and the developing world during the last five decades partly by a rising number of growth collapses. Countries with weak economic structures and institutions and low infrastructural and human development have less capacity to gain from global markets. The report recommends a four-point agenda for domestic development. The main highlights are captured in the following extracts from the address by Mr. Jose Antonio Ocampo, Under-Secretary-General For Economic And Social Affairs to the High-Level Policy Dialogue of the Economic and Social Council on ‘Current Developments in the World Economy and International Economic Cooperation' on 3 July, 2006 in Geneva.

"The world economy has so far performed well this year. Some moderation in global growth is expected, however, in the second semester of 2006. This reflects a number of downside risks that have heightened recently, as partly seen in the conspicuously increased volatility in global financial and commodity markets in May and June.

At the same time, the most positive global economic trend in recent years persists: that is, the rapid and fairly broad growth of the developing countries. In 2006, the developing world will again, as in the two previous years, register a growth rate of more than 6.0 per cent, comparing favourably with 2.7 per cent for the industrialized world. The least developed countries (LDCs) in particular will reach an unprecedented rate of over 7 per cent.

The solid growth figures of developing countries reflect a favourable international economic environment. We see debt relief for some of the world's poorest countries, plus recovery of the commitments in relation to official development assistance. Developing countries have also benefited from strong growth in world trade, from strong commodity prices fuelled by economic expansion in some large developing economies, and, until the first quarter of 2006, from exceptional access to private international capital markets.

Rising international inequality in the long-run is a major concern

Despite the improved breadth of performance by developing countries, both recent and past experience indicate that some of the currently favourable conditions tend to be highly volatile. In fact, as argued in the report - the World Economic and Social Survey 2006, over the past three decades, the incomes of developing countries have on average fallen further behind those of the developed world. International economic inequality has increased. More precisely, since 1980, the world has witnessed a process of dual divergence: an increasing income gap between developed and developing countries, paralleled by a process of growth divergence among developing countries.

Let me turn now to the four major findings of the World Economic and Social Survey 2006. First, success and failure in achieving sustained economic growth appear to be concentrated in time and space. The growth of individual developing countries depends not only on their domestic economic policies - the focus of debates in recent decades - but also on the regional and global economic environments. During the so-called golden age of 1950-1973, most developing regions experienced rapid economic growth. In contrast, the final two decades of the twentieth century brought a worrisomely large number of "growth collapses", with only a few developing economies able to sustain fast rates of growth.

This finding helps to explain our concern about greater international economic inequality. The divergence seen in recent decades has come mainly from growth failures in a large number of countries. This is quite different than a situation in which global inequality is rising because some economies are growing faster than others, but in the end all countries will gain. Moreover, widening global inequality itself diminishes the growth prospects of the less advantaged countries. This is so because markets tend to exacerbate inequality, as successful countries accumulate richer endowments and as capital follows success while those left behind remain more vulnerable to shocks in international financial and commodity markets.

The second major finding of the Survey is that, compared to growth in industrialized countries, growth in developing countries is much less about pushing technological frontiers than about changing the production structure in order to shift resources towards activities with higher levels of productivity. More broadly, sustained economic growth is associated with the capacity to diversify domestic production structure: that is, to generate new activities, to strengthen economic linkages within the country, and to create domestic technological capabilities. The industrial and modern sectors typically contribute dynamically to this diversification process given their: increasing returns to scale, gains from technological progress, engagement in learning by doing, and greater opportunities for forging linkages with other economic sectors. In contrast, de-industrialization and concentration of growth in informal service activities is a certain recipe for growth failures.

Observation of growth patterns suggests that these domestic factors are more important than integration into world markets, and that not all patterns of integration into international markets have the same effect on economic growth. According to the Survey, the countries that profit most from FDI are those whose domestic firms and institutions have the requisite absorptive capacity and help to build domestic technological capability through linkages created between domestic firms and foreign affiliates. At the same time, countries that have integrated into the more dynamic world markets for manufactures and services have performed better than those that have specialized in primary goods and natural resource-intensive manufactures; diversification seems to have been essential for their success. Finally, specializing in low-value added activities with weak domestic linkages generates low economic growth. In sum, a successful export strategy is a question not of how much countries export but rather of what they export and how their export sectors are integrated with other domestic economic activities.

This brings us to the Survey's third major finding: macroeconomic stability, investment and growth are thus mutually reinforcing. But stability means more than low inflation; it also means avoiding strong fluctuations in the business cycle, external imbalances and/or financial crises. This is why counter-cyclical macroeconomic policies play such an important role in economic growth. In this regard, the Survey argues that in recent decades macroeconomic policy in most developing countries has become excessively pro-cyclical, largely determined by volatility of financial markets and commodity prices. Stimulating developing country growth and reducing world inequality will therefore require encouraging and opening up more space for counter-cyclical macroeconomic policies in developing countries.

Insufficient fiscal space, associated with pro-cyclical fiscal adjustment, has also been detrimental to long-term investments in infrastructure and human capital. This further explains growth divergence among countries. The Survey finds, for instance, that lagging infrastructural development likely accounts for as much as one-third of the income gap between East Asia and Latin America. In this respect, the analysis shows that official development assistance, when not determined by geopolitical factors, has had a strong positive impact on long-term growth essentially because in such cases it tends to support long-term investments in infrastructure and human development.

In its fourth major finding, the Survey uncovers a broader definition of institutional reform, encompassing more than creating markets and guaranteeing property rights. It also entails creating the regulatory and institutional framework that markets require to function, providing necessary public goods, and guaranteeing the fairness of rules. Equally important, the analysis shows that institutional reform does not need to be large scale and comprehensive from the outset, and, indeed, that "big bangs" in institutional reform may generate more harm than good. In contrast, minor and gradual institutional change can have a great impact on growth if it is perceived as initiating a further process of credible reform.

Overall, some of the Survey's findings may not appear to be particularly surprising in light of classical perspectives about economic development, but they certainly provide new and meaningful insights in light of the more recent debates on economic growth and development. In this sense, the Survey helps to explain why the conventional strategy followed since the 1980s for closing the income gap between the developing and developed worlds-focused on unleashing market forces and integration into global markets-has been, at best, only partially effective.

An agenda for reducing international economic divergence

The Survey itself advances a strategy for reducing international economic divergence, in calling for an assertive but flexible agenda for domestic development, facilitated by international cooperation and rules that guarantee the appropriate "policy space" for developing countries. Such an agenda should address, among others, the following four issues:

¨ One, fostering active trade and production sector policies to encourage the structural transformation of developing country economies, aimed at encouraging the diversification of production sector structures, creating strong domestic linkages among production activities, and upgrading technologies. International rules should be reviewed in this light, while avoiding at the same time some mistakes of past industrial policies.

¨ Two, open up more space for counter-cyclical macroeconomic policies, striking a better balance between fiscal and monetary prudence and flexibility, and making price stability less an objective in itself than an intermediate goal of economic growth and employment creation. The effectiveness of these domestic policy efforts will also require policy interventions at the international level to dampen financial volatility.

¨ Three, ensuring sustained levels of public spending to make the necessary investments in infrastructure and human capital. This means that additional fiscal space needs to be created through increased efficiency of public expenditures, improved governance and strengthening of the tax base and, for the poorest countries, through additional development assistance (ODA).

¨ Four, promoting gradual, country-specific and home-made institutional reforms. International cooperation can help in this regard by supporting such gradual domestic processes, by fully respecting the principle of ownership of domestic policies and institutions and, particularly, by avoiding the proliferation of institutional conditionality."

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