4 reflections on the current state of the world

When I was the World Bank’s regional chief economist for Africa or the Middle East and North Africa (MENA), I would regularly give a “state of the region” speech, which was often summarized in our semi-annual publications, Africa’s Pulse and the MENA Economic Monitor. Now that I am in a more globally focused position, I decided to give a presentation, with the help of my colleagues that examines the “state of the world.” Below are the major points and the solutions that policymakers should be considering.

The world is seeing increased GDP growth

For the first time since the global financial crisis, we are seeing an uptick in GDP growth rates in all the major regions of the world (the United States, the European Area, Japan, major emerging market countries like Brazil, Russia, India, China, and South Africa, and other developing countries). At any other point in the past decade (Figure 1), one or more of these regions were experiencing a growth slowdown. This is seemingly a moment for celebration, but I recommend proceeding with caution.

Figure 1: Growth is firming up almost everywhere

Underlying economic indicators show cause for concern

These same regions have seen a slowdown in investment growth over the past four or five years, although there has been a recent pickup. This means that potential growth—the growth of the economy if all factors were fully employed—will be limited in the near future, casting doubt on the sustainability of the current resurgence.

Figure 2: Growth may not be sustained because of investment slowdown

Total factor productivity (TFP) growth—the component of growth over and above the growth of labor and capital—has been slowing in developed countries for some time, with slowing beginning in developing countries too. This is troubling because developing countries’ TFP growth is often derived from innovations in developed countries. And in the long run, a country’s GDP growth is strongly associated with its TFP growth. Simulation models of a typical low- to middle-income country reveals that, with a 1 percentage point faster TFP growth rate, its per-capita income in 2050 would be 57 percent higher. This relationship works in the reverse direction too, with slower TFP growth leading to potential growth slowing down.

Trade growth is also slowing. Whereas trade used to grow twice as fast as GDP, the ratio has slowed to one and half times and falling. Some of this is due to a shift in China’s increasingly sophisticated pattern of production, which has moved from buying raw materials, parts, and components from abroad to making inputs domestically. This trend may accelerate with the populist backlash against globalization in some developed countries. Research by David Autor and colleagues shows that, had the growth of Chinese import penetration been 50 percent smaller in the closely contested states in the 2016 U.S. presidential election, Hillary Clinton would have won. Not only did Donald Trump running on an anti-globalization platform win, but he has pulled the U.S. out of the Trans-Pacific Partnership and is currently re-negotiating NAFTA.

Finally, there are signs of increased global financial instability, especially in developing countries. The percentage of non-performing loans (NPLs) is rising, while the amount of provisioning for NPLs (keeping aside capital for future difficulties) is falling. An index that measures vulnerability of corporations’ balance sheets finds that vulnerability was higher in 2016 than in 2009.

Countries need to overcome political hurdles to invest in infrastructure and human capital

If TFP growth is likely to slow, developing countries need to invest in capital and labor as sources of growth. The perennial themes of infrastructure and human capital have become that much more important. Both need public resources, at a time when fiscal space is limited. But is fiscal space limited when so much of the budget is spent on unproductive expenditures? A glaring example is energy subsidies, which continue to be a major component of the budget in MENA. Even though these subsidies deplete the budget, corrode the environment, and benefit the rich disproportionately, they have been difficult to remove. One reason is that politically connected people benefit from them. In Egypt under Mubarak, whereas the share of high-energy-intensive firms among all firms was only 8 percent, the share among politically connected firms was 45 percent. In short, the problem of creating fiscal space is political. Publicizing information about politically connected firms’ benefiting from energy subsidies may help build public support for reforms.

Furthermore, the problem of infrastructure is not necessarily one of money. A study of road transport in Africa showed that vehicle-operating costs along the four major transport corridors were about the same level as in France. But transport prices in Africa were the highest in the world. The difference between transport prices and operating costs is the profit margin that accrues to the trucking companies. Some of these profits added up to 100 percent of the operating costs. How is that possible? The answer is that many African countries have regulations that prohibit entry into the trucking industry. These regulations were introduced 50 years ago, when it was thought that trucking was a natural monopoly. What this has created is a powerful trucking lobby that will resist any attempt at deregulation. It doesn’t help that in at least one country, the president’s relative owns the trucking company. To lower transport prices in Africa, we need deregulation of the trucking industry, not necessarily new roads. One country, Rwanda, did deregulate, and trucking prices fell 75 percent in real terms.

In human capital, too, the problem seems to be much more than just money. Developing countries are succeeding in getting children enrolled in primary schools. The problem is that they don’t seem to be learning. In rural India, about 80 percent of second-graders could not read a single word out of a short paragraph, nor could they do a two-digit subtraction problem. Why? One reason is that, about 24 percent of the time, the teacher is absent. Again, the problem seems to be political, with teachers’ running the political campaigns of local politicians who, when elected, give the teacher a job that he or she doesn’t have to show up to.

Transparency is for success

To make progress on the accumulation of labor and capital, therefore, we need to overcome the political obstacles to reform. How? One way is to publish the information about political capture, so that the public can hold politicians to account for reforms. A somewhat successful example is the Doing Business indicators, which compare 190 countries’ progress in improving business regulations every year. In 15 years, Doing Business has seen significant improvement in the business climate across the board. Whereas in 2005, there were only three countries in Africa where it took less than 20 days to start a business, today over half the countries (27 out of 45) fall into this category.