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Crisis Focus
UPDATED: September 28, 2010 NO. 40 OCTOBER 7, 2010
New Engines for Growth

The global financial crisis changed the global economic order—it also changed the way people think about that order. Once accepted principles and practice have now come into question or are altogether discredited. While the developed world gets its house in order, developing countries are becoming a new engine of global growth and a pulling force for advanced economies. The World Bank recently published its analysis of this trend in a book called The Day After Tomorrow: A Handbook on the Future of Economic Policy in the Developing World. Edited excerpts follow:

Most developed countries came out of the 2008-09 crisis in bad shape. Burdened with extreme debt and facing massive fiscal adjustments (or solvency crises of unimaginable consequences if they do not adjust) they can expect a slow, medium-term recovery at best. Their consumers are retrenching, worried by the loss of wealth (houses and stocks), lack of jobs and stricter lenders. Will this heavy slog drag down the developing world too? Not necessarily. More likely, emerging economies will become a pulling force for advanced ones—they will become a new engine of global growth.

The short-term economic cycles of developing countries have for decades been, and will continue to be, correlated with those in the G7. There has been no "decoupling" of cycles. However, long-term growth trends did separate almost 20 years ago. In the mid-1990s, developing nations began to grow at their own, much faster pace. Part of this had to do with technological convergence; "catching up" is relatively easy. But mostly it was due to better policies.

This superior performance will continue. In fact, projections show that, as a group, the size of developing countries' economies will surpass that of their developed peers by 2015. How is this possible? Because there are several autonomous sources of growth that emerging markets can still tap, as long as they adhere to sensible policies. First, they have room for more leverage in their public and private sector balance sheets. In other words, they will not need to postpone investment for a lack of finance. Second, the expansion of the middle classes will permanently raise the level of domestic demand. Third, technological learning and catch-up may increase, as the cost and risk of transferring knowledge continues to fall. Fourth, trade integration will accelerate with the emergence of production networks that cross borders, and with it, there will be further reallocation of resources (human or otherwise) to higher-productivity activities. Finally, commodity prices will stay high, and commodity revenues will be better managed. The result will be a faster transformation of natural wealth into increases in (or less loss of) productivity.

A less developed country is "less developed" not only because it lacks inputs (labor, capital), but also because it uses them less efficiently. In fact, inputs are estimated to account for less than half of the differences in per-capita income across nations. The rest is due to the inability to adopt and adapt better technologies to raise productivity. As an engine of growth, the potential of technological learning is huge—and largely untapped. Four global trends have begun to unlock that potential and are bound to continue. First, the vertical decomposition of production across frontiers allows less advanced countries to insert themselves in supply chains by specializing in single, simpler tasks. Second, the expansion of "South-South" trade (since 1990, at twice the speed of global trade) increases the availability of technologies that have been tested and adapted to developing-country settings. Third, information and communication technology is becoming ever cheaper and more widely embraced. Fourth, as the middle class grows in emerging economies, local technological adaptations begin to break even.

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