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WASHINGTON, December 11, 2002 — A sluggish global economic outlook, with slower growth in the next 12 to 18 months than previously anticipated, will impede poverty reduction in developing countries, according to a new World Bank report. Action to remove barriers to trade and investment that hurt poor people in developing countries is becoming increasingly urgent.
According to Global Economic Prospects and the Developing Countries 2003: Investing to Unlock Global Opportunities, uncertainties in global financial markets have sapped the momentum of the modest recovery that began in late 2001. The Middle East and North Africa (MENA) also face an economic slowdown, with short-term growth prospects contingent upon whether military actions are taken in the region. The report outlines steps that rich countries and developing countries can take in the current uncertain environment to increase growth rates and speed poverty reduction in developing countries.
Slower Global Growth Undermining Poverty Reduction
After exceptionally slow growth in 2001 and 2002, global GDP is now expected to rise by 2.5 percent in 2003, higher than the previous two years but still well below the 3.8 percent expansion recorded in 2000 and significantly below long-term potential growth rates, according to the report. The report warns that the global rebound might quickly lose momentum and there is a significant risk that the world could slip back into recession.
"The recovery has been much more hesitant and uneven than we had expected," says Nicholas Stern, World Bank Chief Economist and Senior Vice President for Development Economics.
Despite a continuation of high oil prices, growth in MENA declined to 2.5 percent, down from 3.2 percent in 2001, as the events of September 11, 2001 continue to reverberate throughout the region.
For oil exporting countries, growth remained just above 2 percent. The larger increase in growth anticipated from both high oil prices and increased public expenditures were offset by a slowdown in production and exports, a result of tightened OPEC quotas introduced in 2001 to support higher oil prices.
Diversified exporters in MENA faced worsening conditions in 2002, with GDP growth falling to 2.2 percent, a decline of 2 percent from 2001. External factors leading to this decline include the deterioration in export market growth for Egypt, Morocco and Tunisia, as well as sharp declines in the tourism sector in North Africa and several countries in the Levant following the events of September 11, 2001.
Internal factors such as unfavorable weather conditions, tightened fiscal and monetary policies and an unstable exchange rate regime in some MENA countries also served to exacerbate the impact of the economic slowdown stemming from external shocks.
"The bleak growth prospects in MENA have made an already difficult social situation critical, as ever more newcomers to the labor market join the ranks of the unemployed," says Mustapha Nabli, Chief Economist for the Middle East and North Africa at the World Bank.
The latest forecasts indicate that high-income countries are expected to grow at about 2.1 percent in 2003. On average developing countries will grow considerably faster, at 3.9 percent. But the average masks wide regional differences, with East Asia leading the pack at 6.1 percent, followed by South Asia at 5.4 percent. Other regions are expected to grow less than 4 percent, with Latin America managing a mere 1.8 percent. Outside of Asia and Eastern Europe, growth rates in most developing countries are too low to generate a marked reduction in poverty.
According to the report, growth prospects in MENA are clearly contingent upon whether military conflict occurs in the region. If a conflict is averted over the next year and confidence in the region is gradually restored, the region's growth is forecast to increase to 3.7 percent by 2004. A recovery would be expected for both oil-exporting countries and diversified exporters. Growth is expected to average 3.6 percent for the oil-exporting countries, while growth in diversified exports would be expected to increase to 2.7 percent in 2003 and 3.6 percent in 2004.
At the global level, factors suppressing growth in the near term include waning consumer confidence, high debt levels in the face of a weak equity market, and the fallout from corporate financial scandals in the U.S., continuing investor worries over imbalances in the Japanese banking system, and over-investment in telecommunications and other high technology in Europe, as well as concerns about debt problems in Latin America.
In MENA, the effects of military action on confidence in already fragile capital markets may lead to increased spreads and a flight to quality, particularly from countries in the region close to the field of war.
"The MENA region will continue to bear the high costs of conflict and political uncertainty," explains Nabli. "This stifles private investment as well as reform efforts, with negative consequences on long term growth."
The report goes on to describe that even if relatively stronger growth performance is managed in MENA in the short term, growth in the long term is expected to average just over 3.2 percent as countries in the region continue to address several obstacles. According to the report, MENA relies very heavily on a narrow range of external revenue sources, particularly oil remittances and tourism, and this reliance introduces the potential for vulnerability in export earnings.
Private Capital Flows to Developing Countries Down Sharply
The sagging global economy has reduced private capital flows to developing countries. Net commercial bank lending has turned negative, and foreign direct investment flows to developing countries have fallen since their peak in 1999. "We're looking at the most sustained fall in foreign direct investment in developing countries since the global recession of 1981-83" says Richard Newfarmer, lead author of the report.
Private foreign investment in infrastructure is down 25 percent from 1997 in developing countries. Investors are becoming averse to long-term projects; accounting scandals in industrial countries have driven from the market major players such as Enron and Worldcom; and slower growth in East Asia, Russia and Brazil has reduced investment demand.
"Attracting private domestic and foreign investment to infrastructure is essential for development," says Newfarmer. "But in the current environment, many important projects¾ such as in power, roads or water system¾ simply won't be able to attract the necessary private capital. Governments may have no choice but to play a bigger role in financing some activities."
Not only is there less investment, but investors are more discriminating. Investment in developing countries is being redirected to countries with better investment climates.
Action on Doha Trade Agenda More Important Than Ever
Uri Dadush, Director of the Bank's International Trade Department, says that the slowing global economy threatens to distract attention from the need for rapid progress in global trade talks. "It would be unfortunate indeed if a myopic focus on short-term issues permitted protectionist forces to stifle progress in removing trade barriers and other impediments to investment and poverty reduction in developing countries," he says.
Global trade talks launched at Doha in November last year to address the needs of developing countries are showing signs of becoming bogged down. "The U.S. farm bill and the recently announced accord to maintain E.U. spending on farm subsidies until 2013 have complicated agricultural talks," says Dadush. World Trade Organization (WTO) Ministers plan to review progress at the next global trade summit, in Cancun, Mexico, in September 2003.
The Cancun meeting will have to take up, among other things, two new controversial issues, a proposed international investment agreement and requirements for competition policy. Multinational corporations hope such an agreement would provide them with increased market access and new protections against adverse government policies, such as expropriation. However, the report finds that a global agreement to add new investor protections against adverse government policies would probably do little to increase FDI in developing countries.
"Removing barriers to trade and investment that hurt poor people in developing countries should continue to be the main focus of global trade talks-this includes barriers in the rich countries and in the developing countries themselves," says Stern. "Straying too far into domestic regulatory issues without getting this big picture right risks delaying an agreement or producing outcomes that don't really help poor people."
Improving the Investment Climate in Developing Countries
Even in a sluggish global economy, developing countries can do much on their own to promote growth and poverty reduction. While previous Bank studies emphasized good governance, sound institutions, and property rights as necessary conditions to produce greater quantities of private investment, both domestic and foreign, this year's Global Economic Prospects 2003 goes further by considering policies to promote competition as a way of improving the quality of investment¾ that is, making investment more productive.
The report analyzes policy barriers that limit competition in developing countries: trade barriers can prevent import competition; legal restrictions can prevent foreign entry that would increase the number of competitors; state monopolies can prevent entry of private firms, foreign and domestic alike; and badly-designed regulatory regimes in industries that have been privatized can impede both domestic and foreign competitors, to the detriment of consumers.
Addressing one area without addressing the others can produce perverse results: for example, permitting foreign entry behind high tariffs can create foreign-dominated oligopolies that reduce national income. But lowering trade barriers can help compete away monopoly profits. According to the report, increasing imports in concentrated industries from zero to 25 percent of domestic sales reduces oligopoly profit mark-ups by 8 percent through lower prices to consumers. Firms in Korea, Malaysia and Thailand are more productive than firms in India and China, in part because of lower trade restrictions and administrative barriers to entry.
Similarly, although privatizations often have contributed to growth and poverty reduction, privatization itself is no panacea and may not improve outcomes when competition is lacking and the post-privatization regulatory regime is weak.
In MENA for example, countries that rely heavily on privatization revenues to finance increased expenditures could face problems in budget deficits. The temporary nature of receipts from privatization makes reforms in public expenditures and the public sector policies that underlie them and taxation of paramount importance in the future.
"Simply transforming a state monopoly into private monopoly can do more harm than good," says Newfarmer. "The real benefits come from competition to drive productivity improvements and regulations that provide poor people with access to services."The report summary and related materials are available at: http://www.worldbank.org/prospects/gep2003