Developing economies risk falling off the convergence process

The writer is president of Queens’ College, Cambridge and an adviser to Allianz and Gramercy

Around the globe, macroeconomic challenges are mounting, from higher inflation to multiplying shortages of goods and labour.

The impact on advanced economies and China has been much debated. There has been less attention though paid to the vulnerability of a significant group of developing countries.

This goes well beyond the short term. When combined with other forces in play, the most exposed developing countries risk being knocked off a secular global convergence process that many in development economics and finance have taken for granted for years.

An increasing number of economists and policymakers are internalising the new reality of high and more persistent inflation, after too many months of dismissing the phenomenon as “transitory”.

We no longer live in a world where the main macroeconomic challenge is one of weak aggregate demand. Instead, insufficient supply is causing “everything shortages”.

Together with both energy uncertainties and labour market frictions in matching workers to an ample demand for them, this is pushing up both cost and price inflation. It can no longer be assumed that technological innovation will continuously lower costs and increase supply responsiveness. This is especially the case given current supply chain problems.

The focus on what all this means for advanced economies and China is understandable. They account for much of the global economy’s growth engines and flows of capital, and they determine what is pursued seriously on the multilateral agenda.

Yet the implications for commodity-importing developing countries in general, and the lower-income economies in particular, are much more consequential.

Combined with the broader impact of Covid-19, the current problems risk derailing the longer-term process in which more countries steadily climb the economic development ladder, pull citizens out poverty and establish financial and institutional resilience.

As growth slows down in China and the US in the face of stagflationary winds blowing through the global economy, the challenges to these countries’ wellbeing and financial viability increase. The pressures come as the classical growth model for them — that of export-led, labour-intensive manufacturing — has already lost potency.

Being net food importers, many developing economies face higher import costs that also fuel food insecurity. Higher energy costs are threatening to lead to power outages that would cripple industrial production.

Developing economies are also likely to be on the receiving end of disruptive financial market trends. In recent years, the prolonged pursuit of ultra-loose monetary policies in the US and Europe had “pushed” substantial capital to the developing world in search of higher returns.

Should the US Federal Reserve continue to lag inflation realities and subsequently be forced into a sudden policy tightening, the greater the likelihood of large outflows and increased capital costs.

There is no silver bullet to ensure an immediate and substantial reduction in these risks. Instead, what is needed is a multi-measure approach. This should be centred on increasing the supply of Covid vaccines. As Gita Gopinath, the IMF Research Director said last week, 96 per cent of the population in low-income countries remains unvaccinated.

Crippling debt-servicing problems should also be pre-empted through early, orderly restructurings that involve fair burden sharing among both public and private creditors. In addition, the flow of concessional financing from multilateral sources needs to be increased.

Such measures need to be combined with credible, homegrown efforts to re-energise domestic growth models in developing countries and increase internal financial resilience.

Advanced economies should note that troubles in the developing world will also affect them. The more that developing countries risk being knocked off the convergence process, the greater the likelihood of surges in migration, global financial instability and geopolitical threats.

There are also implications for investors. Succeeding in emerging-market investing is becoming less about riding the global liquidity wave using passive products. Instead, investors increasingly have to go back to detailed credit analyses, smart structuring, proper pricing of liquidity — and, for some, an understanding of debt-rescheduling risk.

The more they delay in making this fundamental transition, the more likely they will be shocked into portfolio adjustments that fuel contagion across markets. This would also complicate an already challenged outlook for global prosperity and social wellbeing.


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