Voice of sanity

Print edition : October 14, 2016

The Tanjong Pagar Container Terminal at the port of Singapore. Photo: Bloomberg

For many years now, the annual Trade and Development Report (TDR) produced by UNCTAD (United Nations Conference on Trade and Development) has been a voice of sanity in the global discourse on the world economy that has often appeared to be dominated by denial and irrelevance. The Report has also often proved to be remarkably prescient—for example, anticipating as early as 2006 the likely collapse of financial markets that occurred in 2008, or pointing in the past few years to the futility of excessive reliance on monetary policies alone to lift economic growth, which policymakers are only beginning to come to grips with at present.

This year’s report provides a similarly insightful assessment of current economic trends, which captures the dilemmas facing policymakers across the world. It summarises the poor state of the global economy, with slow growth in advanced economies (expected to be less than 2 per cent this year) and developing countries (around 4 per cent, that is 2.5 percentage points below the pre-crisis figure). Global trade has, meanwhile, decelerated even more and the commodity cycle is now in its second year of sharp downturn even as many commodity prices have been falling since 2012. Capital flows have become more volatile again and debt crises are looming in several countries.

This reflects the unbalanced and unsustainable nature of the supposed recovery from the crisis. As the Overview notes: “Financial markets are chastened but unreformed, debt levels are higher than ever and inequality continues to rise. Most of the upside gains have resulted from asset price rises and increased corporate profits. Meanwhile, most of the downside adjustment has fallen on debtor countries and working families, with wages, employment and welfare provision under constant pressure from a return to austerity measures. This conjuncture might appropriately be described as a “Polanyi period”, in which the regulatory and normative framework on which healthy markets depend, having already warped, is beginning to buckle as the weight of Greenspan’s mistake is felt in an ever-widening swathe of economic and social life—from precarious employment conditions to corporate tax inversions to undrinkable tap water. Trust in political leadership is at an all-time low, just when the need for decisive political action is at an all-time high” (TDR, Overview, page II).

As TDR 2016 notes, a major reason for this situation is the premature return to “business as usual” after the immediate effects of the global financial crisis had been mitigated. Weak demand, particularly in the developed world, remains a major drag on global economic expansion, and extraordinarily loose monetary policies are doing little to revive it. Even higher levels of public debt have failed to stimulate demand and boost growth, largely because these are a consequence of balance sheet adjustments in other parts of the economy. Meanwhile, the real reason for insufficient demand—falling wage shares of national income reflecting stagnant or even declining wage incomes in many countries—is not addressed nor has it been sought to be offset by higher investment spending.

The report notes that the weak labour market conditions and tepid growth cannot be effectively resolved by either financial bubbles or export surges. Financial bubbles can provide a temporary boost at best, but they tend to aggravate the deflationary gap by increasing inequality and create supply-side distortions that impede productivity growth. Export surpluses can certainly benefit countries that achieve them, but are ultimately a beggar-thy-neighbour response in a world of insufficient global demand (TDR, Overview, Page III).

Instead of the current economic strategies that are clearly not working, a change in policy direction is required. For most advanced countries as well as many developing countries, this would require a more proactive fiscal stance, both on spending and taxation, with supportive monetary and credit policies, stronger financial regulation and redistributive measures through an incomes policy, minimum wage legislation, progressive taxation measures and welfare-enhancing social programmes. Obviously, this requires a greater degree of international coordination, especially for developing countries to get the policy space required for sustainable expansion, to manage external shocks and to generate structural transformation. This, in turn, must be delivered through greater flexibility in various international rules and changes in the international trade and investment architecture.

The latter is actually seen to be crucial because this year’s report, in addition to providing acute assessment of the contemporary global economy, also steps back to look more systematically at processes of industrialisation and structural change, which it defines as key to the development project. An examination of the trends in the past 40 years shows that catch-up industrialisation has indeed been relatively rare, mostly evident only in some countries of East and South-East Asia. In these regions, the share of manufacturing in gross domestic product (GDP) rose steadily to cross a threshold of 25 per cent (South-East Asia) or 30 per cent (North-East Asia) and stayed that way for a sustained period of time. This was accompanied by strong employment creation and rising productivity, allowing countries in these regions to successfully enter global markets and drive up the rising share of developing countries in global trade in manufacturing over the past few decades. As the manufacturing sector expanded, primary production also became more efficient because of declining input prices and knowledge spillovers. Similarly, the services sector also developed in conjunction with manufacturing.

In these cases of successful catch-up industrialisation, steadily rising per capita investment was a key factor for reaching a critical mass in manufacturing activities. Various production, knowledge and income linkages were fostered by industrial policy that provided strong government support for selected industries, including public investment in infrastructure, targeted credit allocation, public and publicly sponsored R&D, and access to export markets, as well as policies to influence more equitable distribution of incomes, which in turn boosted domestic demand.

But in other less successful regions and countries, manufacturing growth has fallen below overall output growth, and employment growth has been associated with little productivity growth, or vice versa. Indeed, cases of stalled industrialisation have been much more common in the developing world, as shares of industrial income and employment have stagnated after some growth of manufacturing output, but at lower levels of per capita income and overall productivity (such as in India and Mexico). In some cases, manufacturing slowed even before a solid base for sustained industrialisation could be established, as in many sub-Saharan African countries.

An even more extreme case is that of premature de-industrialisation, in which the shares of manufacturing value-added and employment start to decline at levels of per capita income much lower than those at which developed economies and successful catch-up industrialisers start to de-industrialise, accompanied by declines in relative productivity levels. A number of countries in South America since the debt crisis of the 1980s, as well as some North African countries and several transition economies after the collapse of the centrally planned system, have experienced prolonged periods of productivity stagnation or decline, in most cases coinciding with sharp falls in investment growth. Such premature de-industrialisation was, in general, closely linked to drastic policy changes such as more restrictive macroeconomic policies, lower public investment in infrastructure and knowledge, as well as large and often unilateral trade liberalisation that affected the profitability and viability of manufacturing. Reduced state intervention to support structural transformation tended to be accompanied by more regressive income distribution that weakened domestic demand. TDR 2016 explicitly considers the relationship between trade and industrialisation and, in particular, the much-discussed strategy of export-led industrialisation. It finds that although deeper participation in international trade can increase the pace and extent of industrialisation and raise productivity both within and across industries, this causation is neither simple nor assured. Reciprocal trade liberalisation opens export markets and eases the import of capital goods and intermediate products, but it also generates challenges for domestic industrialisation, such as increasing competition from industrial imports and the fact that export markets for developing countries have become much more crowded and competitive, increasing the globally accessible supply of less-skilled labour at a time of general wage compression and weak aggregate demand.

What has become evident is that other than in a few exceptional cases, export-led industrialisation has generally failed to create broadly shared, high-wage employment. Enclaves of manufacturing excellence, while laudable, tend to be insufficient to generate the linkages and the economy-wide productive transformation required to achieve significant industrialisation. Further, productivity gains may not lead to higher wages and social upgrading; rather, they mostly increase profits or are used to lower prices to ensure competitive advantage.

Of course, it is also true that in the current world economy, many of the weak links between trade in manufacturing and industrialisation can be traced to the problem of deficient global aggregate demand. The report emphasises that growth strategies in both the North and the South that are based on wage compression and fiscal austerity lead to overall insufficient demand. Obviously, it will be increasingly necessary for developing countries to turn to more regional, South-based markets, as is already partly reflected in the changing geography of international trade. But there is a pressing need for a change in policy focus as well, from export-oriented industrialisation to domestic demand-driven industrialisation.

The other important lesson from history is that structural transformation needs a strong investment push, and indeed the later that countries begin to industrialise the more demanding this requirement becomes. At all levels of per capita income, the financing of investment pushes can be a major constraint on development. This is where recent tendencies towards financialisation are of some concern.

In a chapter on the profit-investment nexus, the report points out that growing financial openness and persistent instability in the international financial system have weakened this relationship in both developed and developing economies. Corporate profitability has increased almost everywhere, but investment trajectories have not increased in most countries and have even shown declines in some. This is obviously of great concern not only where a previously strong profit-investment nexus has weakened, but also in countries where such a relationship has yet to be established in the absence of banking systems capable of financing industrialisation. So the need to restrain corporate financialisation is an important issue in developed and developing economies alike. This would require changes in corporate governance and in the incentive structures of non-financial corporations, through regulation of finance as well as more attention to corporate taxation.

Ultimately, this report is a call for renewed attention to industrial policy, not in the simplistic sense of “picking winners” but in considering various strategies for diversification and upgrading to foster strong productivity growth. This means going beyond selecting sectors to building linkages and capabilities, obviously with an eye to policy coherence so as to bring together macroeconomic, financial, trade and industrial policies. These are all eminently sensible suggestions—all that is needed is a broader political environment that will support them.

This article is closed for comments.
Please Email the Editor