Structural transformation for inclusive

and sustained growth

TRADE AND DEVELOPMENT REPORT, 2016

U N I T E D N AT I O N S C O N F E R E N C E O N T R A D E A N D D E V E L O P M E N T

UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENTGENEVA

TRADE AND DEVELOPMENTREPORT, 2016

Report by the secretariat of theUnited Nations Conference on Trade and Development

UNITED NATIONSNew York and Geneva, 2016

Symbols of United Nations documents are composed of capital letters combined with figures.MentionofsuchasymbolindicatesareferencetoaUnitedNationsdocument.

Thedesignationsemployedandthepresentationof the material in this publication do not imply the expression of any opinion whatsoever on the part of the Secretariat of the United Nations concerning the legal status of any country,territory,cityorarea,orofitsauthorities,orconcerningthedelimitationofitsfrontiersorboundaries.

Material in this publicationmay be freelyquoted or reprinted, but acknowledgementisrequested,togetherwithareferencetothedocumentnumber.Acopyofthepublicationcontaining the quotation or reprint shouldbe sent to theUNCTADsecretariat; e-mail: tdr@unctad.org.

Note

UNCTAD/TDR/2016

UNITEDNATIONSPUBLICATION

Sales No.E.16.II.D.5

ISBN978-92-1-112903-8 eISBN978-92-1-058314-5

ISSN0255-4607

CopyrightUnitedNations,2016Allrightsreserved

This Report is dedicatedto the memory of

Gerasimos (Gery) Arsenis,19312016, lead author of the first TDR in 1981

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Explanatory notes .................................................................................................................................... xiii

Abbreviations ............................................................................................................................................. xv

OVERVIEW .......................................................................................................................................... IXV

Trade and Development Report, 2016

Contents

Page

Chapter I

CURRENT TRENDS AND CHALLENGES IN THE WORLD ECONOMY ...................................... 1

A. A year of living dangerously ................................................................................................................ 1

B. Recent trends in the world economy ................................................................................................... 4 1. Growthperformance .......................................................................................................................... 4 2. Internationaltrade .............................................................................................................................. 8 3. Recentdevelopmentsincommoditymarkets .................................................................................. 11 4. Internationalcapitalflowstodevelopingeconomies ...................................................................... 15

C. The slowdown of global trade ............................................................................................................ 17 1. Preliminaryobservationsonthecausesofthetradeslowdown ...................................................... 18 2. Globaltradeinthecontextofinternationalproductionnetworks ................................................... 20 3. Summingupandimplicationsfortheglobaloutlook ..................................................................... 24

Notes ........................................................................................................................................................... 27

References .................................................................................................................................................. 29

Chapter II

GLOBALIZATION, CONVERGENCE AND STRUCTURAL TRANSFORMATION.................... 31

A. Introduction ......................................................................................................................................... 31B. Globalization and convergence ......................................................................................................... 33C. Structural transformation: The missing link(s) ............................................................................... 43D. A global enabling environment? ........................................................................................................ 47E. Conclusions .......................................................................................................................................... 51Notes ........................................................................................................................................................... 52References .................................................................................................................................................. 53

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Page

Chapter III

THE CATCH-UP CHALLENGE: INDUSTRIALIZATION AND STRUCTURAL CHANGE ....... 57

A. Introduction ......................................................................................................................................... 57

B. The case for developing manufacturing industries .......................................................................... 58 1. Thevirtuesofmanufacturing .......................................................................................................... 58 2. Knowledgelinkagesandproductivitygrowth ................................................................................. 60

C. Trends in structural change since 1970 ............................................................................................. 61 1. Long-termtrends ............................................................................................................................. 61 2. Impactofstructuralchangeandinvestmentonaggregateproductivity .......................................... 67

D. Successful and stalled industrialization and premature deindustrialization ................................ 76 1. Catch-upindustrialization ................................................................................................................ 76 2. Stalledindustrialization ................................................................................................................... 78 3. Prematuredeindustrialization .......................................................................................................... 82

E. Making the primary and tertiary sectors work for structural transformation ............................ 83 1. Theroleoftheprimarysectorinstructuralchange ......................................................................... 83 2. Makingcommodityexportrevenuesworkforstructuraltransformation ........................................ 84 3. Theroleofservicesinstructuraltransformation ............................................................................. 86

F. Conclusions .......................................................................................................................................... 89

Notes ........................................................................................................................................................... 90

References .................................................................................................................................................. 92

Chapter IV

REVISITING THE ROLE OF TRADE IN MANUFACTURES IN INDUSTRIALIZATION ......... 97

A. Introduction ......................................................................................................................................... 97B. A preliminary framework .................................................................................................................. 98C. Trends in international trade by region .......................................................................................... 101 1. Generaltrends ................................................................................................................................ 101 2. Tradeinmanufactures ................................................................................................................... 106

D. Structural transformation, productivity growth and trade .......................................................... 110 1. Tradeinmanufactures,valueaddedandstructuraltransformation ............................................... 110 2. Growthinlabourproductivityandtradeinmanufactures ............................................................. 113 3. Exportsophisticationanddiversification ...................................................................................... 115

E. Global value chains, industrial upgrading and structural transformation ................................. 118

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Page

F. Gender, industrialization, trade and employment ......................................................................... 122 1. Exportorientationandwomensemployment ............................................................................... 122 2. Employmentelasticityofexport-orientedmanufacturing ............................................................. 124

G. The past and future of pricing power ............................................................................................. 128

H. Conclusions ........................................................................................................................................ 131

Notes ......................................................................................................................................................... 133

References ................................................................................................................................................ 134

Chapter V

PROFITS, INVESTMENT AND STRUCTURAL CHANGE ............................................................ 139

A. Introduction ....................................................................................................................................... 139

B. Theprofit-investmentnexusrevisited ............................................................................................. 141

C. Corporatestrategies:Refocusingandfinancialization ................................................................. 146

D. The corporate investment environment in developing countries ................................................. 149 1. Challengingmacroeconomicconditionsforprivateinvestment ................................................... 151 2. Microeconomictrends:Incipientcorporatefinancializationindevelopingcountries? ................. 155 3. Structuraltransformationandfinanceforinvestment:Sectoralpatternsof

(financialized)investment .............................................................................................................. 160

E. Reinvigorating investment in developing countries ....................................................................... 162 1. Tacklingglobalfinancialinstabilityandcorporatefinancialization .............................................. 162 2. Establishingafunctioningprofit-investmentnexusinthecontextofcatch-updevelopment ....... 164 3. Combatingtaxavoidance,evasionandcapitalflight .................................................................... 166

F. Conclusions ........................................................................................................................................ 168

Notes ......................................................................................................................................................... 169

References ................................................................................................................................................ 171

Chapter VI

INDUSTRIAL POLICY REDUX ......................................................................................................... 175

A. Introduction ....................................................................................................................................... 175

B. Reassessing the scope of industrial policy ..................................................................................... 176 1. ThelonghistoryofState-sponsoredstructuraltransformation ..................................................... 176 2. Learningfromsuccessesandfailures ............................................................................................ 177

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Page

C. The varying geometry of State-business relations ......................................................................... 179 1. InstitutionsofthedevelopmentalState........................................................................................179 2. Government-businessrelations.....................................................................................................181 3. Support,performanceanddiscipline............................................................................................182

D. Reassessing the tools of industrial policy ........................................................................................ 185 1. Targetingactiveandpassiveindustrialpolicies ............................................................................ 185 2. Managingrents .............................................................................................................................. 188 3. Strengtheninglearningcapabilities ............................................................................................... 188

E. Integrating trade, macroeconomic and structural policies ........................................................... 191 1. Astrategicapproachtotheroleofinternationaltrade ................................................................... 191 2. Macroeconomicmatters ................................................................................................................ 193 3. Revivingtheprofit-investmentnexus ............................................................................................ 196 4. Policiestobetterintegratetheprimarysector ............................................................................... 197

F. Conclusions ........................................................................................................................................ 198

Notes ......................................................................................................................................................... 199

References ................................................................................................................................................ 201

Annex to chapter VI

Growth and Structural Change: An Updated Assessment of the Role of theRealExchangeRate ......................................................................................................................... 205

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List of tables

Table Page

1.1 Worldoutputgrowth,20082016...................................................................................................5 1.2 Exportandimportvolumesofgoods,selectedregionsandcountries,20122015.......................9 1.3 Worldprimarycommodityprices,20102016.............................................................................12 1.4 CommodityconsumptioninChina,selectedcommodities,20022015......................................14 1.5 Averagelevelsoftariffsbetweencountrygroupsin2014andchangesbetween2008and2014....19 2.1 Industrialgrowthrates,selectedcountriesandregions,18702014............................................32 2.2 GrowthofrealGDPpercapitaatpurchasingpowerparity,selectedregions

andeconomies,19512015..........................................................................................................38 2.3 Probabilityofcatch-upwiththeUnitedStates,byincomegroup,19501980and19812010......42 3.1 Shareofindustryintotalvalueaddedandemployment,selectedgroups

andeconomies,19702014..........................................................................................................63 3.2 Shareofmanufacturingintotalvalueaddedandemployment,selectedgroupsand

economies,19702014................................................................................................................65 3.3 Averageannualgrowthratesoftotalvalueadded,valueaddedinindustryand

totalemployment,selectedgroupsandeconomies,19702014..................................................68 3.4 Averageannualgrowthratesofinvestment,totallabourproductivityand

labourproductivityinindustry,selectedgroupsandeconomies,19702014.............................69 3.5 Averageannualproductivitygrowthinselectedregionsbydrivingfactor,variousyears...........72 3.6 Percapitainvestmentandinvestment-to-GDPratio,selectedgroupsand

economies,19702014.................................................................................................................74 3.7 Ratioofmanufacturingproductivitytoselectedservicesproductivity,selectedeconomies,

20002010....................................................................................................................................88 4.1 ShareofexportsofgoodsandservicesinGDP,bycountrygroup,19702014........................102 4.2 ExportsofmanufacturesasashareofGDP,bycountrygroup,19802013..............................107 4.3 ImportsofmanufacturesasashareofGDP,bycountrygroup,19802013..............................108 4.4 Sharesofexportsofhigh-andmedium-skillandtechnology-intensivemanufactures

intotalexportsofmanufactures,bycountrygroup,19802013................................................109 4.5 Responsivenessofemploymenttoexportsofmanufacturesandindustrialgrowth,

bygender,19912014...............................................................................................................126 4.6 Elasticity of labour share in total income vis--vis the women-to-men employment ratio

andtheshareofmanufacturesinGDP,19912014...................................................................127 4.7 Annualgrowthinthetermsoftrade,bycountrygroup,19802014........................................130 5.1 Firmssourcesofinvestmentfinanceandconstraintsontheiraccesstoexternalfinance,

bysizeoffirm,selectedcountrygroups,20082015...............................................................145 5.2 Sizeofthefinancialsystem,selectedindicatorsandeconomies................................................152 5.3 Non-financialcorporations:Investmentandselectedfinancialindicators,19952014.............156 5.4 Non-financialcorporations:Debtindicatorsandleverageratios,19952014...........................157 6.A.1 Regressionofeconomicgrowthonundervaluationmeasure,19502014.................................206

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List of charts

Chart Page

1.1 Importvolume,selectedcountrygroups,January2004April2016.............................................9 1.2 Monthlycommoditypriceindicesbycommoditygroup,January2002June2016...................13 1.3 Netcapitalflowsforselectedcountrygroups,20002016..........................................................15 1.4 Averageglobaltariffs,19952014...............................................................................................18 1.5 Degreeofimportdependencyofexportingindustriesinselectedcountries,20022014............20 1.6 Manufacturingexports,wageearningsandGDPofselectedcountriesrelativetothose

oftheworld,19852014...............................................................................................................22 1.7 Globalwageshare,19852014....................................................................................................23 1.8 Globaltradegrowth,creditexpansionandfiscaldeficitsinthemaincurrentaccountdeficit

countries,19862015...................................................................................................................24 1.9 Conditionalprojectionsofglobaltradegrowthandrelatedvariablesinthemain

currentaccountdeficitcountries,20052020...............................................................................26 2.1 Tradeandfinancialopenness,selectedcountrygroups................................................................34 2.2 Globalexportsasashareofworldoutput,19602014................................................................35 2.3 Globalcurrentaccountsurplusesanddeficitsasashareofworldoutput,19802014................35 2.4 Stocksandflowsofinwardforeigndirectinvestmentasashareofglobaloutput

bycountrygroup,19702014.......................................................................................................35 2.5 Worldoutputgrowthrate,19512015.........................................................................................37 2.6 RatioofGDPpercapitaofselectedcountriesandcountrygroupstoGDPpercapita

oftheUnitedStates,19502015..................................................................................................39 2.7 GDPpercapitagapbetweendevelopingcountriesandtheUnitedStates,1990and2014.........39 2.8 RealGDPgrowthinselectedcountrygroups,19712014..........................................................43 2.9 Labourproductivityinthemanufacturingsectorandintheoveralleconomyinselected

developingregions,19602010....................................................................................................44 2.10 Fixedinvestmentinselectedrapidlygrowingcountries,18602015..........................................45 2.11 Shareinglobalmerchandiseexports,selectedeconomies,19502015.......................................46 2.12 Numberofsystemicbankingcrisesbycountrygroup,19702012............................................48 2.13 Internationalcapitalflowsandfixedinvestmentasaproportionofworldoutput,19802014.....49 3.1 Shareofeconomicsectorsintotalvalueadded,bycountrygroup,19702014..........................62 3.2 Shareofmanufacturingintotalvalueadded,bycountrygroup,19702014..............................64 3.3 Employment,valueaddedandproductivitybyeconomicsectorinselectedcountrygroups,

various years.................................................................................................................................71 3.4 Averageannualgrowthratesofemploymentandproductivityinmanufacturing,

selectedcountriesandregions,variousyears...............................................................................79 4.1 Developinganddevelopedcountriesshareinworldexportsinmanufacturesand

selectedcommodities,1995and2014........................................................................................103 4.2 Compositionanddirectionofexports,selectedregions/groups,20002014.............................104 4.3 ChangesinthesharesofexportsofmanufacturesandmanufacturingvalueaddedinGDP

between19911994and20112014,selectedcountriesbyregion............................................111

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4.4 Changesindomesticvalueaddedinexportsofmanufacturesandintheshare ofmanufacturingintotalvalueadded,selectedeconomies,19952011................................... 112

4.5 LabourproductivitygrowthandexportsofmanufacturesasashareofGDP............................ 114 4.6 Relationshipbetweenexportsophisticationandpercapitaincomegrowth,

selecteddevelopingeconomies.................................................................................................. 116 4.7 Changesinthesharesofforeignvalueaddedinmanufacturingexportsand

ofmanufacturingvalueaddedinGDP,19952011....................................................................120 5.1 Profits,investmentsanddividenddistributionofnon-financialcorporations,

selectedcountries,19602015....................................................................................................142 5.2 Corporateprofitsandinvestment(excl.construction),19802015...........................................143 5.3 Investmentinselectedeconomiesandcountrygroups,19702014..........................................150 5.4 Grossoperatingsurplus,byregion/subregion,19802015........................................................151 5.5 Debtservice-to-incomeratiooftheprivatenon-financialsectorofdevelopingand

developedcountries,20072015................................................................................................154 5.6 Investmentasaproportionoftotalcapitalstockofnon-financialand

manufacturingfirmsinBrazilandSouthAfrica,20002014.....................................................160 5.7 Sectoral contribution to the increase in the nominal value of total debt and

capitalstockbetween2010and2014.........................................................................................161

2.1 Middle-incometroubles................................................................................................................40 4.1 Genderedpatternsinindustrialemployment..............................................................................124 5.1 Chinesenon-financialcorporatedebtontherise.......................................................................158 5.2 Creatingadevelopment-orientedfinancialsystem:Theroleofthecentralbank

oftheRepublicofKorea............................................................................................................165 6.1 Industrial policy and the role of intermediary institutions: The Ethiopian experience ..........182 6.2 Governmentprocurementandindustrialpolicy.........................................................................186 6.3 IndustrialcouncilsinUruguay...................................................................................................190 6.4 Servicesanddiversification:Aroleforindustrialpolicy?..........................................................194

Box Page

Chart Page

List of boxes

xiii

Explanatory notes

Classification by country or commodity group

TheclassificationofcountriesinthisReport has been adopted solely for the purposes of statistical or analytical convenienceanddoesnotimplyanyjudgementconcerningthestageofdevelopmentofaparticularcountryorarea.

Thereisnoestablishedconventionforthedesignationofdeveloping,transitionanddevelopedcountriesorareasintheUnitedNationssystem.ThisReportfollowstheclassificationasdefinedintheUNCTAD Handbook of Statistics 2015(UnitedNationspublication,salesno.B.15.II.D.8)forthesethreemajorcountrygroupings(seehttp://unctad.org/en/PublicationsLibrary/tdstat40_en.pdf).

Forstatisticalpurposes,regionalgroupingsandclassificationsbycommoditygroupusedinthisReport follow generallythoseemployedintheUNCTAD Handbook of Statistics 2015unlessotherwisestated.ThedataforChinadonotincludethoseforHongKongSpecialAdministrativeRegion(HongKongSAR),MacaoSpecialAdministrativeRegion(MacaoSAR)andTaiwanProvinceofChina.

Thetermscountry/economyrefer,asappropriate,alsototerritoriesorareas.

ReferencestoLatinAmericainthetextortablesincludetheCaribbeancountriesunlessotherwiseindicated.

Referencestosub-SaharanAfricainthetextortablesincludeSouthAfricaunlessotherwiseindicated.

Other notes

ReferencesinthetexttoTDR are to the Trade and Development Report(ofaparticularyear).Forexample,TDR 2015 refers to Trade and Development Report, 2015(UnitedNationspublication,salesno.E.15.II.D.4).

References in the text to theUnitedStatesare to theUnitedStatesofAmericaand those to theUnitedKingdomaretotheUnitedKingdomofGreatBritainandNorthernIreland.

Thetermdollar($)referstoUnitedStatesdollars,unlessotherwisestated.Thetermbillionsignifies1,000million.Thetermtonsreferstometrictons.Annualratesofgrowthandchangerefertocompoundrates.ExportsarevaluedFOBandimportsCIF,unlessotherwisespecified.Useofadash()betweendatesrepresentingyears,e.g.19881990,signifiesthefullperiodinvolved,includingtheinitialandfinalyears.Anobliquestroke(/)betweentwoyears,e.g.2000/01,signifiesafiscalorcropyear.Adot(.)inatableindicatesthattheitemisnotapplicable.Twodots(..)inatableindicatethatthedataarenotavailable,orarenotseparatelyreported.Adash(-)orazero(0)inatableindicatesthattheamountisnilornegligible.Decimalsandpercentagesdonotnecessarilyadduptototalsbecauseofrounding.

xv

Abbreviations

BEPS baseerosionandprofitshiftingCIF costinsuranceandfreightCIS Commonwealth of Independent StatesECB EuropeanCentralBankECLAC EconomicCommissionforLatinAmericaandtheCaribbeanEU European UnionFOB free on boardFDI foreigndirectinvestmentGATT GeneralAgreementonTariffsandTradeGDP grossdomesticproductGVC globalvaluechainHNWI high-net-worthindividualICT informationandcommunicationtechnologyIEA InternationalEnergyAgencyIMF InternationalMonetaryFundIPO initialpublicofferingISIC InternationalStandardIndustrialClassificationLDC least developed countrymbd million barrels per dayMFN most favoured nationMIT middle-income trapMNE multinational enterpriseNBTT net barter terms of tradeNIE newlyindustrializingeconomyNPL non-performingloanNTM non-tariff measureOECD OrganisationforEconomicCo-operationandDevelopmentOPEC OrganizationofthePetroleumExportingCountriesPIAC PresidentialInvestorsAdvisoryCouncilPPP purchasingpowerparityQE quantitativeeasingR&D research and developmentRER realexchangerateSDG SustainableDevelopmentGoalSITC StandardInternationalTradeClassificationSOE State-owned enterpriseTDR TradeandDevelopmentReportTTRI tariff trade restrictiveness indexUNCTAD UnitedNationsConferenceonTradeandDevelopmentUNDESA UnitedNationsDepartmentofEconomicandSocialAffairsUNECA UnitedNationsEconomicCommissionforAfricaUNIDO UnitedNationsIndustrialDevelopmentOrganizationUNSD UnitedNationsStatisticsDivisionUNWTO UnitedNationsWorldTourismOrganizationVAT value-added taxWTO WorldTradeOrganization

I

OVERVIEW

In 1997, the Trade andDevelopmentReport argued that a return to faster growth and full employment in developed economies was a prerequisite for tackling the problem of rising inequality, and warned that failure to achieve this could provoke a backlash against globalization, which might put the gains of global economic integration at risk.

What happened next in the developed economies was a short boom-bust cycle linked to the dot-com bubble, followed by a period of steady growth and slowly falling unemployment. This was backed by an easy monetary policy in the United States that shored up investor confidence, triggered a surge of international capital flows and boosted global trade. Economists suggested that the world had entered a period of great moderation. Some proceeded to explain how hyperefficient, self-regulating markets, under the watchful eye of astute central bankers, had finally overcome the challenge of what then Federal Reserve Chairman Alan Greenspan called risk transfer and financial stability.

It was a comforting narrative, but one which ignored how growth was being fed by a massive explosion of debt and an unhealthy addiction to high-risk bets amongst financial market players. In this great gambling, inequality, rather than falling, continued to rise, in some countries to levels not seen since the 1920s.

The luck of the financiers finally ran out, beginning with the subprime crisis in early 2007 and ending with the collapse of the investment bank, Lehman Brothers, in September 2008. Sentiment transformed swiftly from euphoria to panic, not only sending financial sectors across the globe into a tailspin, but also triggering the biggest global contraction since the Great Depression.

Governments intervened rapidly to save their financial systems, turning on the money tap as well as initiating more targeted actions tailored to local circumstances; and the G20 stepped in to coordinate a Keynesian-style fiscal expansion. Greenspan apologized, acknowledging that I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms.

Thirty quarters after the crisis hit, developed countries are still struggling to return to a solid growth path, and policymakers were predicting tougher times ahead even before Brexit gave another jolt to financial markets. Growth forecasts have been regularly scaled back, and a new vocabulary has emerged to describe an underperforming economy faced with the choice between episodic growth spurts and financial stability. Developing economies, having for a while believed they had decoupled from events in the developed economies, are increasingly worried that policy actions in the latter could trigger a deflationary spiral and a new round of debt crises.

II

While the current situation seems less ominous than in 2008, it is proving more difficult to manage. With the financial system on a firmer footing, politicians and policymakers have recovered their sense of impotence in the face of supposedly insurmountable global forces, and have made business as usual their default policy option. 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 Greenspans 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. This is particularly true for a series of interconnected global challenges, codified in the Sustainable Development Goals, which can only be met through effective international cooperation and action.

Reflecting on a similar period between the two world wars, Karl Polanyi insisted that a great transformation would be needed if markets were to work for a stable and prosperous future for all. Trust would have to be rebuilt, regulations strengthened, and rights and representation expanded. Western governments after the Second World War were able to strike a balance between market-driven efficiency and the demands for shared prosperity and greater economic security. Managing such a transformation in our highly interconnected global economy is todays big political challenge, for countries and communities at all levels of development.

The global economy: A year of living dangerously

Theworldeconomyin2016isinafragilestate,withgrowthlikelytodipbelowthe2.5percentregisteredin2014and2015.Themediocreperformanceofdevelopedcountriessincethe20082009economicandfinancialcrisisissettoendure,withtheaddedthreatthatthelossofmomentumindevelopingcountriesoverthepastfewyearswillbegreaterthanwaspreviouslyanticipated.Withoutachangeofcourseintheformer,theexternalenvironmentfacingthelatterlookssettoworsen,withpotentiallydamagingconsequencesforboththeirprosperityandstabilityintheshorttomediumterm.Morewidespreadcontagionfromunforeseenshockscannotberuledout,knockingglobalgrowthbackmoresharply.ThedecisionbyvotersintheUnitedKingdomtoleavetheEuropeanUnion(EU)isonesuchshock.

GrowthintheUnitedStatesthisyearislikelytoslowdown,asthemomentumthatwasbuiltthroughthequickdetoxificationofitsbankingsystemandamoreaggressiveuseofmonetarypolicylosestraction.Moreover,givenitsweakunderlyingemploymentrate,thenumberofdistressedhouseholdswithhighlevelsofdebtandexportersalreadystrugglingwithastrongdollar,therearenoguaranteesthattheeconomywillenjoyarobustperiodofgrowthanytimesoon.

RecoveryintheeurozonehaslaggedbehindthatoftheUnitedStates,inpartbecauseofthemoretimiduseofmonetarypolicyintheyearsimmediatelyfollowingthecrisisandagreaterproclivityforsevereausteritymeasuresinsomemembersofthezone.Thetentativepick-upofgrowthfrom2015seemslikelytostallthisyear,andcouldevenbereversedduetotheuncertaintytriggeredbytheannounceddepartureoftheUnitedKingdomfromtheEU.Economicgrowthcontinuestobeheldbackbyweakdomesticdemandandonlysporadicsignsofanimprovementinrealwages.Effortstotacklethesharplydivergingeconomicperformancesofthecountriesintheeurozonearecomplicatedbypoliticaluncertainties,suchastheongoingmigrationcrisis,anddoubtsaboutthefuturepaceanddirectionofEuropeanintegration.

III

Europeaneconomiesoutsidetheeurozonehaveperformedbetterinrecentyears,mainlybecausethemonetaryauthoritiesinmanyofthosecountrieshavebeenwilling,andable,toorchestratefinancialbubbles.TheeconomyoftheUnitedKingdom,evenwithoutthethreatofBrexit,wasdestinedforadifficultperiodowingtoitshighlevelofindebtednessandapersistentlylargetradedeficit.ThelongertermconsequencesoftheBrexitvotearestillunclear,giventheunprecedentednatureofthedecisionandthepoliticaluncertaintyithascreated,thoughgrowthwillundoubtedlyslowdownintheshortterm.Justhowsteepthedropcouldbe,giventhehighlyfinancializedandflexiblemarketsintheUnitedKingdom,isdifficulttopredict.

Japan continues to exhibit a distinct set of economic characteristics stemming fromdecades ofunderperformance,withpersistently lowand erratic growth accompaniedby a lowunemployment rateandadecliningactivepopulation,ahighdomesticdebtandastrongpaymentsposition.Consumptionhasremainedslackduetostagnantwages,leavingexportsasthepreferredsourceofexpandingdemand.Inrecentyears,withtheweakeningofglobalmarketsandanappreciatingyen,effortshaveturnedtostimulatingtheeconomythroughgovernmentspending,butwithonlyamodestresponsesofar.

Theupshotisthatcontinuingweakdemandindevelopedeconomiesisstiflinggrowthintheglobaleconomy.Theexpectedpositiveimpactsoflowercommodityprices,particularlyoil,havenotmaterialized.Higherlevelsofpublicdebtarefailingtostimulatedemandandboostgrowth,largelybecausetheseareaconsequenceofbalancesheetadjustmentsinotherpartsoftheeconomy.Thepersistentdragongrowthinmostdevelopedcountriesisduetoafallingwageshareandinsufficienthouseholddemandthathavenotbeenoffsetbyhigherinvestmentspending.

Neitherfinancialbubblesnorexportsurgesofferasustainablesolutiontothetepidgrowthandweaklabourmarketconditions.Financialbubblescanprovideatemporaryboost,atbest,buttheytendtoaggravatethedeflationarygapbyincreasinginequality,andcreatesupply-sidedistortionsthatimpedeproductivitygrowth.Exportsurplusescancertainlybenefitcountriesthatachievethem,butareultimatelyabeggar-thy-neighbourresponseinaworldofinsufficientglobaldemand.

Intheabsenceofconcertedrecoveriesinthedevelopedeconomies,internationaltradeisinthedoldrumsforthefifthstraightyear.Todate,protectionisttendencieshavebeenkeptincheck,butrisksurfacingiftherealcausesofthisslowdownarenottackledeffectively.Themajorproblemisweakglobaldemandduelargelytostagnantrealwages.

The slowdownof tradehas stalledgrowth inmanydeveloping countries, particularly commodityexporters,andrecentgrowthspurtshavereliedlargelyoncapitalinflows.Ascapitalbeginstoflowout,thereisnowarealdangerofenteringathirdphaseofthefinancialcrisiswhichbeganintheUnitedStateshousingmarketinlate2007beforespreadingtotheEuropeansovereignbondmarket.

Developingeconomieswilllikelyregisteranaveragegrowthrateofslightlylessthan4percentasin2015butwithconsiderablevariationacrosscountriesandregions,alongwithmountingdownsiderisks.Damagingdeflationaryspiralscannotberuledout.Indeed,thesearealreadyoccurringinsomecountries,includinglargeemergingeconomiessuchasBrazil,theRussianFederationandSouthAfrica,whererecessionhasreturned,orisimminent,withlikelynegativespillovereffectsonneighbouringeconomies.

Othereconomiesarealsosetforhardtimesahead,smallercommodityproducersbeingparticularlyvulnerable.Thecommoditycycleisinitssecondyearofasharpdownturn,andthecommoditypriceindexiswellbelowthelevelitwasatwhenthefinancialcrisishit.Withinvestorsstillexitingdevelopingandtransitioneconomies,netcapitalflowsturnednegativeinthesecondquarterof2014,andamountedto-$656billionin2015and-$185billioninthefirstquarterof2016.Eventhoughtherewasarespiteinthesecondquarterof2016,thereremainsariskofdeflationaryspiralsinwhichcapitalflight,currencydevaluationsandcollapsingassetpriceswouldstymiegrowthandshrinkgovernmentrevenues,andcauseheightenedanxietyaboutthevulnerabilityofdebtpositions.

IV

Sizecanprovidesomewhatofabufferagainststrongheadwindsfromtheglobaleconomy.Thetwolargestdevelopingeconomies,ChinaandIndia,mayescapetheworstoftheadverseexternalenvironmentduetotheirexpandingdomesticmarketsandacombinationofsufficientforeignreservesandaneffectiveuseoftheirpolicyspace.

Chinaseconomyhassloweddownsharplyoverthepastfewyears,althoughitisstillmaintainingarelativelyhighgrowthrateof6.57percent.Whilethispartlyreflectsitsongoingshiftawayfromanexcessiverelianceonexternalmarketstoboostgrowth,thesurgeofdomesticcreditinresponsetothecrisishascreatedadebtbubblewhich,alongwithexcesscapacityinseveralsectorsoftheeconomy,willnotbeeasytomanageifitbursts.Financialvolatilityinearly2016,whichsawcapitaloutflowsfromChinaofaround$160billioninthefirstquarteroftheyearandafurtherdropinforeignreserves,isawarningsignofthepossibleturbulenceahead.

India has so farmanaged the downside risks of the post-crisis periodbetter thanother emergingeconomies,andisnowgrowingfasterthanChina.Privateinvestment,whichbeganrisingstronglyfromthestartofthemillennium,continuedtogrowevenasthecrisishit.However,itisnowshowingsignsofweakening,alongwithemergingdebtservicingdifficulties.Meanwhilepublicinvestmenthasyettotakeoff,exposinginfrastructuregapsthatcouldhinderfuturegrowth.

Working out the debt problem

Inrecentyears,developingcountrieshavesteadilyopenedtheirdomesticfinancialmarketstonon-residentinvestors,foreignbanksandotherfinancialinstitutions,andhaveeasedrestrictionsontheirownresidents investingabroadtoallowportfoliodiversification.Inaddition, theirfinancial institutionshavediversifiedintocross-borderactivitiesunrelatedtointernationaltradeandinvestment.Thesedevelopmentshavedeepenedtheirfinancialintegrationandamplifiedboomconditionsacrossalldevelopingregions.Buttheyhavealsocreatednewsourcesofvulnerability.

Therehavebeengrowingconcernsaboutfinancialfragilityinemergingeconomiesduetoadelugeoffinancialflowsandcheapcreditsince2009,fueledtoaconsiderableextentbyextensivequantitativeeasingprogrammesindevelopedeconomies.Alarmbellshavebeenringingforawhileovertheexplodingcorporatedebtincurredbyemergingmarketeconomies.AccordingtotheBankforInternationalSettlements,thedebtofnon-financialcorporationsintheseeconomiesincreasedfromaround$9trillionattheendof2008tojustover$25trillionbytheendof2015,anddoubledasapercentageofgrossdomesticproduct(GDP)from57percentto104percentoverthesameperiod.Pastexperienceshowsthatifmuchofthenon-performingprivatesectordebtislargeanddenominatedinforeigncurrency,asinLatinAmerica,forexample,ittendstoenduponpublicbalancesheets,thusriskingasovereignexternaldebtcrisis.TheexceptionisChina,wherecorporatedebtisabout170percentofGDP,upfrom100percentin2008,butitmainlyconsistsofdomesticbondsandclaimsbydomesticbanks.Whilethereisnodangerofanexternaldebtcrisis,thehighdebtlevelisexertingconsiderablepressureonthedomesticbankingandfinancialsector.

Inpoorerdevelopingeconomies,thebenefitsreapedfromthedebtreliefinitiativesofthe1990sandearly2000sandarushedintegrationintointernationalfinancialmarketspost-2008,arefastevaporating.Onlyacoupleofyearsago,theamountofdebtthatlow-incomedevelopingeconomiescouldhavesoldtoeagerinvestorsseemedalmostlimitless.Internationalsovereignbondissuanceintheseeconomiesrosefromamere$2billionin2009toalmost$18billionby2014.Butaprolongedcommoditypriceshock,steepcurrencydepreciationsandworseninggrowthprospectsinadeterioratingglobaleconomicenvironmenthavequicklydrivenupborrowingcostsanddebt-to-GDPratios.

Iftheglobaleconomyweretoslowdownmoresharply,asignificantshareofdeveloping-countrydebtincurredsince2008notonlydebtissuedandheldwithinthebordersofindividualeconomies,butalso

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cross-borderdebt,includingdebtaccumulatedbyprivateresidentsandgovernmentscouldbecomeunpayableandexertconsiderablepressureonthefinancialsystem.Thus,theinternationalcommunitywillneedtoprepareitselfformanagingdebtwork-outsinafaster,fairerandmoreorderlymannerthanithasdonesofar.

Changing policy direction

Aworldeconomypopulatedbyconsumerswith insufficientpurchasingpowerand toomuchdebtandproducerswithlargeprofitsandaweakpropensitytoinvestisunlikelytoprovidethestableeconomicfoundationonwhichasustainableandinclusivefuturecanbebuilt.Atthesametime,globalproductivitygrowthappearstobestuck,addingtotheunbalancedstateoftheworldeconomy.Thisisduenotleasttotheprotractednatureoftherecoveryfromthe2008crisis.However,theweightoffinancialmarketsoneconomicdecision-makingandtherelatedriseofinequality,bothofwhichhaveincreaseduncheckedoverseveraldecades,isofparticularconcern.Inadditionthereisgrowingrecognitionthatexcessiveconcentrationinsomemarkets,alongwithexcessivecompetitioninothers,iscompoundingeconomicimbalancesandaddingtothedifficultiesforpolicymakingeverywhere.

Separately, a slowdownof productivity growth, rising inequality, insufficient global demand andmountinglevelsofdebtrepresentenormouschallengesforpolicymakersatthenationalandinternationallevels.Togethertheyposeaseriousthreattosharedprosperityandstability.Theworrythatanunforeseenevent, such asBrexit, could triggerwidespread economic disruption is nowbeing put to the test.TheInternationalMonetaryFund(IMF)haswarnedpolicymakerstobealert;perhapsitisalsotimeforthemtobecomealittlemorealarmed.

Whilethereisagreementthatthesechallengesarecloselyinterconnected,thereisnosignofaconcertedmovetowardspolicycoordinationamongsystemicallyimportanteconomies.TheUnitedStateshasbeguntorecognizethatitseconomicpolicydecisionshaveimpactsbeyonditsownborders,withtheFederalReserverespondingwithamorecautiousstanceoninterestraterises.Butamoreambitiouspolicypackageisneededtoaddressexistingimbalancesandeasetheconstraintsonfastergrowth,whetherinlargeorsmallcountries,surplusordeficiteconomies,commodityormanufacturingexporters,creditorsordebtors.Aglobalnewdealwillneedtomovebeyondbusinessasusual.

AsarguedinpastTrade and Development Reports,thepolicypackageindevelopedeconomieswillneedtocombineaproactivefiscalstance,bothonspendingandtaxation,withsupportivemonetaryandcreditpolicies,strongerfinancialregulationsandredistributivemeasuresthroughanincomespolicy,minimumwagelegislation,progressivetaxationmeasuresandwelfare-enhancingsocialprogrammes.Thespecificpolicymixwill,ofcourse,varyacrosscountries,althoughlargepublicinfrastructurespendingwouldneedtobeacommonthread.Developingcountriesalsowillneedtoadoptproactivepoliciesincludingfiscal,financialandregulatorypoliciestorestoregrowthratestotheirpre-crisislevelsandensurethatsuchgrowthismoreinclusiveandsustainable.Forthis,theywillrequiresufficientpolicyspacebothtomanageunforeseeneconomicshocksandtopursuethekindofstructuraltransformationstrategiespreviouslyundertakenbytodaysdevelopedeconomies.Suchpolicyspaceshouldbeguaranteedthroughmoreflexibleinternationalrules.Otherinitiativesthatneedtobetakenatthemultilaterallevelincludemeasuresaimedatstemmingtaxevasionandavoidance,andfinancinginfrastructuredevelopmentwithalow-carbonfootprint.

Therearesignsthatinternationalbodies,suchastheIMF,arerethinkingtheirapproachtomacroeconomicadjustmentalongtheselines.Thenecessarynextstepisforthemtomoveawayfromanarrowdiscussionofstructuralreformthatpromotesafamiliarpackageofliberalizationandderegulationmeasures,andinsteadconsiderthewiderangeofactionsneededtodiversifythestructureandlevelofsophisticationofeconomicactivity.Suchactionsshouldaimto increaseproductivity,createmoreandbetter jobs,boosthouseholdincomes,increasefiscalrevenuesandinvestment,andfostertechnologicalprogress,andallthisinthecontextofaworldthatisrapidlymovingtowardsalow-carbonfuture.

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The antinomies of globalization

Beginningintheearly2000s,alldevelopingregionssawgrowthacceleratesignificantlymorethanindevelopedcountries,andatapacewhichhelpedbringaboutadramaticreductioninlevelsofextremepoverty.InsomecountriesitalsohelpedreduceincomegapswiththeNorth.Thisconvergencetrendcontinuedintheaftermathofthefinancialcrisis,butisnowlosingsteamasgrowthdeceleratesacrossthedevelopingworld.Lessonsneedtobedrawnfromthisrecentexperienceifconvergenceistoresumeandbeguidedalongmoretransformativegrowthpaths.

Lookingattheperiodsincetheearly1980s,itispossibletodiscernthreemajortrendsthathavehelpedreshapetheglobaleconomiclandscape:thepersistentslowdownofdevelopedeconomies,theconsistentlystrongperformanceofEastAsia,andtheunevenperformanceofotherdevelopingcountries,bothovertimeandacrossregions.

EastAsiaseconomic take-offbegan in the1960swith thenewly industrializingeconomies in theNorth-East,andspreadSouth-Eastinthe1980s,albeitwithaweakermomentum.ItwasreinvigoratedinthenewmillenniumasChinaspost-reformtransformationtookhold.Ofthe11fastestgrowingnon-islanddevelopingeconomiessince1980,9arefromEastAsia.

Elsewhereinthedevelopingworldcatch-upgrowthhasbeenmoreintermittent.Indeed,manydevelopingcountriesarefurtherbehindthedevelopedeconomiestodaythantheywerein1980,despiterecentgrowthspurts.

Onepossibleexplanationforthisvariationrelatestothereconfiguringoftheglobalenvironmentoverthepastthreedecades,whichhasbenefitedsomecountries(andcommunities)butheldbackothers.Certainlyaconfluenceoffavourableeconomicfactorsgreatertradeandcapitalflows,increasedremittancesandaidflows,andhighercommoditypricesexplainsthegeneralaccelerationofgrowthacrosstheSouthatthestartofthemillennium,butsuchgrowthoccurredalongdevelopmentpathsthathadbeensetintheprevioustwodecades.Astheglobaleconomictidebeginstoebb,thosepathsarebeingexposedtotheelementsofalessfavourableenvironment.

Thebiginvestmentpushthatwasexpectedtodrivestructuraltransformationindevelopingregionsremainsoneoftheunfulfilledpromisesofamoreopenglobaleconomy.Financialopennesshascertainlyimprovedaccesstocapitalandmadeitcheaper,whileforeigndirectinvestmenthasreconfiguredsegmentsoftheinternationaldivisionoflabour.However,capitalflowsinmostdevelopingcountrieshavebecomemorevolatile,andhavenotalwaystriggerednewinvestmentsinproductivecapacityorchangedproductivestructures.Shocksandcriseswerefrequentthreatstoforwardplanninguntiltheearly2000s,whenashort-livedperiodofcalmwasestablishedandinvestmentincreased,albeitgingerly.Takingtheperiodsincetheearly1980sinitsentirety,thereappearstohavebeenaweak,andpossiblyinverse,relationshipbetweencapitalformationandfinancialopenness.

Another feature of the contemporaryglobalizationprocesswhichmight offer some clues to thesevariedgrowthexperiencesisthereconfiguringofmarkets.Freecompetitivemarketsareafavouritetextbookprescriptionforenhancingeconomicprosperity,anditisassumedthatthelargerthosemarketsthegreaterwillbetheprosperity.Inreality,somemarketshavebecomesubjecttoincreasingconcentrationasahandfuloffirmshaveemergedwiththeresourcestogaincontrol,whileothermarketshaveexperiencedanintensificationofcompetition.Thedangerwithsuchacombinationisrentextractioninsomeareasandaracetothebottominothers.Asaresult,differentcountriesarefacingverydifferentopportunitiesandpressures.

Globalmarketscanbegoodservantsbutbadmasters;andcedingmoreauthoritytothosemarketsisamatterofpoliticalchoice,noteconomicortechnologicaldestiny.Theeconomicslowdownindevelopedeconomies rulesoutanysimpleexplanation that thosechoicesare theproductofa riggedNorth-South

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game.Indeed,thecombinationofslowergrowthandrisinginequalityintheseeconomieshasleftitsowntrailofdepressedcommunities.Thebigpoliticalchallengefacingtheinternationalcommunityisthereforetomovebeyondamappingofthewinnersandlosersfromglobalizationtoamoreconstructivenarrativeofbuildingsharedprosperity.

Missing linkages

Developmentis,atitscore,atransformationalprocess,combiningaseriesofinteractiveandcumulativelinkagestocreateavirtuouscircleofgreaterresourcemobilization,increasingemployment,higherincomes,expandingmarketsandmoreinvestment,leadingtobetterjobs.Strongaggregateproductivitygrowthisthefuelthatkeepsthiscirclegoing,providingpolicymakerswiththeroomtobettermanagetrade-offsandconflictinginterests,andofferingthepotentialtonarrowgapswiththedevelopedeconomies.

Productivity growth inmost developing regions kept pacewith developed countries until the late1970s.Thetendencysincethenhasbeenoneofdivergence,bothonaverageandacrosssectors,and,withtheexceptionofcountriesinAsia,ithascontinuedevenaseconomicgrowthhaspickedupinsomecountriessincethestartofthenewmillennium.

Thesetrendshavegeneratedrenewedinterestintheroleofstructuraltransformationinfosteringsustainedeconomicgrowthanddevelopment,reflectedinthenew2030AgendaforSustainableDevelopment,oneofthegoalsofwhichisinclusiveandsustainableindustrialization.

However,thestrikingdifferencebetweenEastAsiaandotherdevelopingregionsoverthepastthreedecadesorsoliesnotsomuchintherelativeweightofindustryintotaloutput,butofmanufacturingactivity.TheseregionsstandoutinthattheshareofmanufacturinginGDProsesteadilytocrossathresholdof25percent(South-EastAsia)or30percent(North-EastAsia)andwasmaintainedforasustainedperiodoftime.Therapidgrowthofmanufacturingwasaccompaniedbystrongemploymentcreationandrisingproductivity,allowingthesecountriestosuccessfullyenterglobalmarketsanddriveuptherisingshareofdevelopingcountriesinglobaltradeinmanufacturesoverthepastfewdecades.Inotherregions,manufacturinggrowthhasfallenbelowoveralloutputgrowth,andemploymentgrowthhasbeenassociatedwithlittleproductivitygrowth,orviceversa.

Insuccessfulcatch-upexperiences,supportforthemanufacturingsectorwasnotattheexpenseofother sectors; rather various intra- and cross-sectoral linkages and complementarities further enhancedproductivityandemploymentgrowth.Asthemanufacturingsectorexpandedprimaryproductionalsotendedtobecomemoreefficientasaresultofdeclininginputpricesaswellastechnologyandknowledgespillovers.Similarly,theservicessectortypicallydevelopedinconjunctionwithmanufacturing,withcertainserviceactivitiesbeingspunofffromcontinuedprogressinmanufacturing.Theseactivitiesalsoofferedscopeforproductivityincreases,whichhelpedenhancethepotentialforfurtherproductivitygrowthintheindustrialsectorbyprovidingmoreandbetterqualityinputstomanufacturingprocesses.

Overthepastfivedecades,productivityhasgrownthefastestindevelopingregionswheretheinvestment-to-GDPratioandinvestmentpercapitawerethehighest,orwhereinvestmentgrowthwasthefastest.Inadditiontoinvestmentinproductivecapacityandtechnologicalupgrading,improvementsandadaptationofworkersskills,managementknow-howandentrepreneurialcompetencehavebeenkeytosuccessfulstructuraltransformation.Thecompositionofmanufacturingactivities,intermsoflow,mediumandhightechnology,hasmajorimplicationsforhowknowledgeandskillacquisitionoccurs.Whenlearningtakesplaceindesignandengineeringactivitiesthatcanbeappliedinabroaderspectrumofsectors,industrialproductionischaracterizedbysteeplearningcurvesthatfavourtheemergenceofintersectorallinkagesandimprovedefficiencyoverall.

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Thedistributionofthegainsfromproductivityincreasesinmanufacturingactivitiesalsoaffectsthepaceandsustainabilityofthetransformationprocess.Ifproductivitygainsareusedpredominantlyforincreasingprofits, those profitsmaybe reinvested in additional productive capacity and technological upgrading,but such reinvestment is not guaranteed and needs incentives, including a supportivemacroeconomicframeworkandprospectsofexpandingdemand.Totheextent thatproductivitygainsalsotranslateintohigheremploymentandwages,theyleadtostrongerdomesticdemand,whichcaninduceentrepreneurstofurtherinvest,andtotheemergenceofeconomiesofscalefordomesticallyproducedgoodsandservicesofmassconsumption.Strongproductivitygainsalsoboostgovernmentrevenuesthroughhighercorporateandincometaxeswithoutanabsolutereductioninprivatesectorincomes.Thoserevenuescanbechannelledintoproductivity-enhancinginfrastructureinvestments,includingtheprovisionofpublicutilitiesandservices.Finally,productivitygainsmaytranslateintolowerpricesforexportedgoods,therebyhelpingtogainormaintainglobalmarketshares.

Publicspendinghasplayedacrucialroleintheprocessofstructuraltransformation.Transport,logisticsandtelecommunicationinfrastructures,powerandwaterutilities,theprovisionofeducation,professionaltrainingandresearchanddevelopment(R&D)support,andinformationandcoordinationservicesstronglyinfluenceproductivitygrowthinallsectors,aswellasthepaceandpatternofstructuraltransformation.

Investment,bothpublicandprivate, isnot,however, sufficient to sustain theprocessof structuraltransformationoveraprolongedperiod;buildinglinkagesbetweenleadingsubsectorsandtherestoftheeconomyisalsocritical.Linkagestakeavarietyofforms.Backwardproduction linkages arise as producers procureinputsfromothers,andforwardlinkagesstemfromsupplyinginputstoothers,bothwithinthemanufacturingsectorandintheprimaryandservicessectors.Investment linkages occur as the viability of an investmentinproductivecapacity,newentrepreneurialventuresandtherelatedextensionofmanufacturingactivitiesinoneenterpriseorsubsectortypicallydependsonpriororsimultaneousinvestmentinotherfirmsorsectors,orspecificinfrastructures.Knowledge linkagesarecreatedfromspilloversofskillacquisitionandtechnologicallearningamongfirmsthroughformalandinformalchannelsandfromeducation,professionalformationandR&Dconductedoutsidefirmsbeingputtoeffectiveusebyvariousfirms.Income linkages leadtochangingconsumptionpatternswhengrowingincomeslinkedtoimprovedemploymentconditionstranslateintohigherdemandfordomesticallyproducedgoods,andwhenhigherproductivitygainsorrentsfromnatural-resourceexploitationleadtoanincreaseinpublicrevenues,enablinggreaterpublicinvestmentandserviceprovision.

Althoughmarketincentivescancontributetotheemergenceandstrengtheningoftheselinkages,thisrarelyhappensspontaneously.Indeed,differencesacrosscountriesinactivelybuildinglinkagesgoalongwaytowardsexplainingthevaryingstructuraltransformationpatternsacrossthedevelopingworld.

Using a broad brush approach, it is possible to identify three different trajectories of structuraltransformationoverthepastfewdecades.Suchstylizedtrajectoriesofferaframeworkforlearningfromsuccessesandfailures,andfordesigningappropriatepolicyresponses.Thefirstcategoryisthatofcatch-up industrializationwithrobustproduction,investment,knowledgeandincomelinkagesbuiltoverseveraldecadesbasedonagrowingandincreasinglydiversifiedmanufacturingsector.Otherthanintodaysdevelopedeconomies,thispathcanbeobservedonlyinasmallnumberofEastAsiannewlyindustrializedeconomies,althoughitspotentialhasbeenexhibitedinsomeothercountriesforshorterperiodsoftime.Chinaalsoappearstobeonthispath,thoughatamuchlowerlevelofdevelopment.

Theseexperiencesofcatch-upindustrializationconfirmsteadilyrisingpercapitainvestmentasakeyfactorforreachingacriticalmassincertainmanufacturingactivities.Theyalsodemonstratethecrucialroleplayedbythevariouslinkages,whichwerefosteredthroughstronggovernmentsupportforselectedindustries,includingtargetedcreditallocation,publicandpublicly-sponsoredR&D,andpromotionofaccess

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toexportmarkets.Thepublicsector facilitated long-terminvestment inplantandequipment, includingthroughconsiderablepublicinvestmentinbothphysicalandrelevantknowledgeinfrastructure.Inaddition,thecreationorstrengtheningof income linkageswassupportedbypolicies to influencemoreequitabledistributionofincomes,whichinturnboosteddomesticdemand.

Muchmore common amongdeveloping countries have been cases of stalled industrialization, inwhichsharesofindustrialincomeandemploymentbegintostagnateafterprolongedperiodsofgrowthofmanufacturingoutput,butatlowerlevelsofpercapitaincomeandoverallproductivity.ThishasbeenthecaseinIndiaandMexico,forexample,and,morerecently,inseveralcountriesinSouth-EastAsia.Inothercountries,theexpansionofmanufacturingslowedevenbeforeasolidbaseforsustainedindustrializationcouldbe established, such as inmany sub-SaharanAfrican countries. In countries experiencing stalledindustrialization,productivitygrowthhas tended tofluctuate, andhas rarelymatchedeven theweakestperiodsinEastAsia.Moreover,ithasnotbeenaccompaniedbyasustainedexpansionofemploymentinmanufacturing.

Inmanyofthesecountries,therehavebeenpocketsofexcellence,wheretherehasbeensimultaneousgrowthofproductivityandemploymentinsubsectorsoftheeconomy,suchasinsomeservicesinIndia,andinenclavesofmanufacturingdynamisminMexicothathaveaheavyFDIpresenceandhavebenefitedfrompreferentialaccesstotheNorthAmericanmarket.However,spillovershavebeenlimited.AhybridpathhasbeenfollowedinsomecountriesinSouth-EastAsia,suchasIndonesia,MalaysiaandThailand.Theyexperiencedpositivestructuraltransformationuntilthelate1990s,withcontinuousincreasesinemploymentandproductivityacrossabroadrangeofindustrialactivities,includingmanufacturing,basedonrisingratesofinvestment.However,the19971998Asianfinancialcrisisledtoasignificantreductionofinvestmentratesandthestallingofearlierprogressinemploymentandproductivityinmanufacturing.

Insub-SaharanAfrica(excludingSouthAfrica),themanufacturingsectorhasnevermanagedtoreachthescaleneededtodriveacumulativeprocessoflinkage-building.Inmanycountries,structuraladjustmentpoliciesinthe1980sand1990shadanegativeimpactontheexpansionofmanufacturing.Thesubsequentrecovery of growth inmanufacturing outputwas based on higher employment rather than improvedproductivity,andhasremainedinsufficienttocreatestrongproductionandincome-relateddemandlinkages.Investmentlevels,eventhoughincreasing,haveremainedtoolowrelativetorequirementstodrivebroad-basedproductivitygrowthandknowledgegenerationanddiffusion.

The third trajectory of structural transformation is one of premature deindustrialization, in which thesharesofmanufacturingvalueaddedandemploymentstartedtodeclineatlevelsofpercapitaincomemuch lower than thoseatwhichdevelopedeconomiesandsuccessfulcatch-up industrializersstarted todeindustrialize.Thisisaccompaniedbyasharpfallinrelativeproductivitylevels.ThistrajectoryhasbeenobservedinanumberofcountriesinSouthAmericasincethedebtcrisisofthe1980s.Theseeconomieshaveseenperiodsofproductivitystagnationordecline,insomecasesquiteprolonged,andinmostcasescoincidingwithsharpfallsininvestmentgrowth.Indeed,therateofcapitalaccumulationinLatinAmericahasbeenthelowestamongdevelopingregionsinthepost-1970period.AsimilartrajectoryisevidentforcountriesinNorthAfrica,aswellasseveraltransitioneconomiesthatexperiencedthecollapseofacentrallyplannedsystem.

Prematuredeindustrializationhasbeencloselylinkedtodrasticpolicychangesinthedirectionofmorerestrictivemacroeconomicpolicies,lowerpublicinvestmentininfrastructureandknowledge,and,moregenerally,reducedStateinterventiontosupportstructuraltransformation.Large,andsometimesunilateral,tradeopening,coupledwithperiodsofcurrencyappreciation,stronglyaffectedtheprofitabilityandviabilityofimportantsegmentsofthemanufacturingsector,whileatrendtowardsmoreregressiveincomedistributionweakeneddomesticdemand.

X

Reconnecting trade to structural transformation

Developingcountrieshavegreatlyincreasedtheirshareinglobalexportsofmanufactures,whichgrewfromaround10percentin1980tonearly45percentby2014.AboutonequarterofthattradeisSouth-South,reflectinginparthowglobalvaluechains(GVCs)haveextendedthereachofinternationalproductionnetworksinsomekeytradablesectorsoftheglobaleconomy.Thesedevelopments,andthetradeliberalizationthatfacilitatedthem,arewidelyviewedasapromisingindicatorofthepotentialforglobalizationandtradetosupportindustrializationandspeedupdevelopment.

Partofthereasonwhyexport-ledindustrializationissuchafavouredstrategyisbecauseofthesuccessesofthefirst-tierEastAsianeconomies,wheretheexpansionofexportsofmanufactureswassupportedbyindustrialpolicyandmacroeconomicmanagementresultinginthefastestandmostsustainedrecordofcatch-updevelopmentinthemodernera.Variantsofthisapproachhavespreadtoothercountriesintheregion,thoughtheyhavenotbeenabletofullyemulatethesuccessoftheregionsfirst-movers.Toalargeextent,aggregatestatisticsontheriseoftheSouthinmanufacturingtradebeliethesingularityofAsiasachievements.In2014,Asiaaloneaccountedfornearly90percentofdeveloping-countryexportsofmanufacturestotheworld,andfor94percentofSouth-Southtradeinmanufactures.Nevertheless,anumberofdevelopingcountriesoutsidetheAsiaregionengageinsignificanttradeinmanufactures,withmanymorepursuingsuchtradeinthehopeofrealizingthepromiseofexport-ledindustrialization.

Althoughdeeperparticipationininternationaltradebothexportingandimportingcanincreasethepaceandextentofindustrialization,andraiseproductivitybothwithinandacrossindustries,theserelationshipsareneithersimplenorassured.Tradeliberalization,ifreciprocal,opensexportmarketsandeasesaccesstotheimportofcapitalgoodsandintermediateproducts,butitalsointroducesanumberofpotentialchallengesfortheindustrializationprocess.Perhapsmostformidableistheprospectofincreasingcompetitionfromindustrialimports,whichhasbeenlinkedtoprematuredeindustrializationandinformalizationacrossanumberofcountries.Anotherchallengeisthatexportmarketshavebecomemuchmorecrowdedandcompetitive,increasingthegloballyaccessiblesupplyofless-skilledlabouratatimeofgeneralwagecompressionandweakaggregatedemand.

Whether and towhat extent the export ofmanufactures induces industrialization andproductivitygrowthdependsonboththecompositionofexportsofmanufactures(themoretechnologically-intensivethebetter),andtheirshareofdomesticvalueadded.Moreover,scaleprobablymattersasmuchastheshareofdomesticvalueaddedandtechnologicalintensity,notleastbecauseoftheneedtoabsorblabourintomanufacturing activities in order to achieve aggregate productivity growth.Enclaves ofmanufacturingexcellenceareencouraging,buttheyareinsufficienttogeneratethelinkagesandtheeconomy-wideproductivetransformationrequiredtoachievesignificantindustrialization.

Evenwherescalemaybelargeenoughtosubstantivelyshapedomesticproduction,theproblemofpriceisstillaconstrainingfactor.Thefallacyofcompositionasanevermorecrowdedfieldofexporterspursuethesameexport-ledstrategycompressesprice(andultimatelywage)growth,evenforthemostsuccessfulmanufacturing exporters inAsia.The termsof trade for developing-country exporters ofmanufacturesdeclinedatanaverageannualrateof1.1percentbetween1980and2014,andby1.5percentforexportersofmanufacturesinAsia.Movingtomoretechnology-intensiveexportsseemsapromisingalternative,buttheleaphastobelargeandsustainedtooutpacethemanycompetitorsvyingforthesamehigherpricedexportmarkets.Theflipsideofthefallacyofcompositionistheconcentrationofmarketandpricingpower.TheriseofGVCsisbothacauseandaconsequenceofthisphenomenon.Ontheonehand,GVCsfacilitateawiderparticipationofdevelopingcountriesinglobaltradeofmanufactures,therebyopeningnewavenuesforindustrialization.Ontheotherhand,thiswiderparticipationgeneratesmorecompetition,whichfurtherstrengthensthebargainingandpricingpowerofleadmultinationalenterprises(MNEs)basedpredominantlyindevelopedeconomies.Thismakesitdifficultfordeveloping-countryproducerseventhelargeemergingmarketsupplierstoraiseandcapturevalueaddedineconomicallyconsequentialways.

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Abigpartoftheproblemisthatexport-ledindustrializationinthecurrenterahasbeenagenerallydisappointing generator of broadly shared, high-wage employment anoften overlookedbut essentialaspect of successfully linking exporting and industrialization.Evenwhere productivity gains offer thepotentialforsocialupgrading,theymaymostlyincreaseprofits,orbeusedtolowerpricestosolidifyanexistingcompetitiveadvantage,ratherthanraisewages.Ifmostoftheproductivitygainsaretransferredabroadvialowerprices,thevirtuouscircleofproductivitysupportingdomesticdemandandinvestmentmaybeweakened.ThesecompetitivedynamicshavebeenparticularlyproblematicforcountriesinAfricaandLatinAmerica,whereglobalizationhasbeenassociatedwiththemovementoflabourfromhigh-tolow-productivityproduction,butalsototheinformaleconomy.Conversely,anumberofAsiancountrieshave been better able to exploit the opportunities created by exports of manufactures with a simultaneous increaseinproductivityandemployment.

Theseemploymentpatternsareparticularlypronouncedwhendisaggregatedbygender.InAfricaandinLatinAmericaandtheCaribbean,growthinexportsofmanufactureshasbeenmorestronglyassociatedwithanincreaseinwomensemploymentinlowproductivityservicesectorjobsratherthaninthehighproductivitymodernmanufacturingjobsthatexport-ledindustrializationstrategieswereexpectedtocreate.InAfricabetween1991and2014,a1percentincreaseinexportsofmanufactureswasassociatedwitha0.34percentincreaseinwomensemploymentinservices,butonlya0.12percentincreaseintheiremploymentinindustry.ThecomparablefiguresforwomeninLatinAmericaandtheCaribbeanare0.29percentinservicesand0.14percentinindustry.Thecausalmechanismhereistwofold.Ontheonehand,increasedcompetitivepressuresinexportanddomesticmarketshaveinducedmoreoutsourcingandtheproliferationofinformalwork.Ontheotherhand,combiningdomesticlabourwithmorecapital-intensiveproductiontechnologieshasbothloweredtheemploymentintensityofmanufacturingandraisedtherelativedemandforskilledlabour.Ultimately,itmustberecognizedthatpartofmanagingstructuralchangeinvolvesdesigninganemploymentpolicythatensuresinclusiveandself-sustainingprocessesofindustrialization.

Manyof theweak links between trade inmanufactures and industrialization canbe traced to theproblemofdeficientglobalaggregatedemand.Growthstrategies,inbothNorthandSouth,basedonwagecompressionandfiscalausteritymean there isnotenoughdemand in the traditionaldeveloped-countrydestinations for export-led industrializers.Turning towardsmore regional, South-basedmarkets offersapromisingalternativeparticularly forexportsofmanufacturesas isalreadypartly reflected in thechanginggeographyofinternationaltrade.Butasuccessfulshiftrequiresthatdevelopingcountries,especiallylargeemergingeconomies,changetheirfocusfromexport-orientedindustrializationtodomestic-demanddrivenindustrialization.Developed-countrymarketsstillserveasimportantdestinationsforsellingmoresophisticatedgoods, andprovide critical opportunities for enhancingproduction, design andmarketingcapabilities.However,noneofthesestrategiesarecapableofsustainingindustrializationunlesstheyaresupportedbygrowingglobalaggregatedemand.

An unhealthy investment climate

Structuraltransformationneedsastronginvestmentpush.Thebroadsweepofhistorysuggeststhatsuchapushisbecomingmoredemandingthelatercountriesbegintoindustrialize.Butevenformiddle-incomeeconomiesthathavebuiltsomeinitialcapacity,movingaheadoftenrequiresarenewedpushtobreakthroughspecificconstraints.Financinginvestmentpushescan,atallincomelevels,beamajorconstraintonthedevelopmentprocess.

Conventionalwisdomputsitsfaithinfinancialmarketstochannelavailablehouseholdsavingstothosebestabletousethemproductively.Butinthemoresuccessfulexperiences,governmentshaveplayedaleadroleinusingtheavailableeconomicandinstitutionalspacetocreateconditionswithinwhichamixtureofpublicandprivatefinancecanbemobilizedforlong-terminvestmentprojects.Accesstocreditwasoftencriticalforkick-startinganinvestmentdrive,anditisnoaccidentthat,amongthedevelopingregions,East

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Asiahasthemostadvancedcreditsystemwiththehighestinvestment-to-GDPratios.However,intheseandothersuccessfulcountries,mobilizingtherequisitedomesticresourceshasinvolvedincreasesincorporateprofitsand in theprofitshare inagrowingGDP,suggesting thatprofitshavebeenbothacauseofandconditionalonincreasesinproductiveinvestment.Thisdynamicprofit-investmentnexushasbeenkeytosustainedstructuraltransformation.

Howevergrowingfinancialopennessandpersistentinstabilityintheinternationalfinancialsystemhavenotonlyweakenedtheprofit-investmentnexusindevelopedeconomies,butalsoshowsignsofcorrodingthatnexusindevelopingcountries,withpotentiallydamagingconsequencesforsustainablestructuraltransformation.

Indevelopedeconomies,substantialincreasesincorporateprofitabilityoverthepast30orsoyearshavenotbeentheresultofrisinglevelsofrealinvestment.Inleadingdevelopedeconomies(France,Germany,Japan,theUnitedKingdomandtheUnitedStates),whileaverageinvestment(excludingconstruction)fellsteadilyfromaround20percentofGDPin1980tohistoricallylowlevelsofbelow16percentofGDPin2015,profitsharesfollowedtheexactoppositetrajectory,risingfromanaverage14.6percentin1980tojustbelow18percentin2013(notwithstandingtemporaryslumpsduringthedot-combubblesandtheglobalfinancial crisis). In these economies, corporate profitability has beendriven increasingly by thefinancializationofcorporatestrategies,linkedtotheriseofso-calledshareholderprimacyandafocuson short-termdecision-making, costmanagement andfinancial engineeringunder thewatchful eyes ofinstitutionalinvestors.Whilethepacehasvariedacrosscountries,corporaterefocusingthroughmanagerialpracticessuchasincreaseddividenddistribution,stockbuybacks,mergersandacquisitionshasmeantthatconventionalretainandinveststrategieshavebeenprogressivelyreplacedbythemantratodownsizeanddistribute.

The repercussions at the macroeconomic level have been felt clearly in developed economies in the formofrisingincomeinequalities(dueinparttoexecutiveremunerationschemes),progressivetaxerosionand,ultimately,weakeningaggregatedemand,joblessgrowth,financialbubblesandfurtherrisesinincomeinequality.Asaresult,theprofit-investmentnexusissteadilyunravelling.

Meanwhile,indevelopingcountries,theadverseeffectsoffinancialglobalizationhavebeenapparentfor some time,particularly in the formofmacroeconomicshocks,butmore recently these impactscanbeclearlydiscernedatthecorporatelevel.Balancesheetdataofnon-financialfirmsinlargedevelopingeconomiesshowedadecline in investment-to-profit ratiosbetween1995and2014,withasharp fall insomecountries,suchasinBrazil,Malaysia,theRepublicofKoreaandTurkey.Whileinmostdevelopingeconomieslargeshareholdingcorporationsarestilltheexceptionratherthantherule,thereareclearsignsthattheirstrategies,too,arebecomingmorefinancialized.Forthosefirmsthatregularlydistributedividendsindevelopingeconomies,theshareofpayoutsisontheincreasedespiteroughlystableprofits.Firmsinthiscategoryarealsoaccumulatingfinancialassets, insomecasesfasterthancorporatedebt, indicatingbothalackofprofitablelong-terminvestmentopportunitiesaswellasgreaterportfolioinvestmentchoicesinliberalizedfinancialmarkets.Rapidincreasesintheindebtednessofnon-financialcorporationsarefastbecomingaseriousconcerninmanyemergingeconomies.

Therewasa40percentincreaseinthedollar-denominateddebtofnon-financialcorporationsin13selecteddevelopingcountriesbetween2010and2014,aperiodduringwhichtheirdebt-to-serviceratiosalsosoaredasolidwarningindicatorofsystemicbankingcrisesinthemaking.Bythismeasure,theindebtednessofthesecorporationsskyrocketedbynolessthan40percentagepointsbetweenend2007andend2015.Bywayofcomparison,levelsofindebtednessofnon-financialcorporationsinsomemajordevelopedeconomies(Germany,Japan,theUnitedKingdomandtheUnitedStates)fellbyalmost20percentagepointsoverthesameperiod.

Whileitwouldbeprematuretosuggestageneralizedbreakdownoftheprofit-investmentnexusinthedevelopingworld, it isevident that,whereascorporateprofitabilityhasbeenon the increasealmosteverywhere, investment trajectories have varied considerably among countries.Moreover, the adverse

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macroeconomicimpactsofglobalaswellascorporatefinancializationareclearlyincreasing.Thishasbeenthecasenotonlywhererecentsurgesincorporateindebtednessinemergingeconomieshavebeenfuelled,atleastinpart,byquantitativeeasingprogrammesindevelopedcountries,andtheenormousexcessliquiditytowhichthishasled.Inadditionsector-leveldatarevealhowdebt-fuelledinvestmenthasbeenconcentratedinhighlycyclicalandnatural-resources-basedsectors thatdonotcontributetostructural transformationandfastproductivitygrowth.Indeed,onlysevensectorsoilandgas,electricity,construction,industrialcommodities,realestate,telecommunicationsandminingexplainmorethantwothirdsofthetotalincreaseinbothdebtandinvestment.

Reining in corporatefinancialization, in developed and developing economies alike,will requirechangesincorporategovernanceandintheincentivestructuresofnon-financialcorporations,forexamplebystrengtheningregulatorylinksbetweencorporatetaxationandprofitreinvestmentforproductivepurposes.

Formanydeveloping countries in the early stages of structural transformation,what is of criticalimportanceisnotaddressingtheweakeningofapreviouslystrongprofit-investmentnexus,butestablishing suchanexusinthefirstplace.Thisrequireslarge-scaleeconomicandinstitutionaleffortstobuildeffectivebanking andfinancial systems capable of providing adequate credit and liquidity for rapid productiveexpansion.Italsorequiresproactivepolicymeasurestoovercomeearlyhurdlestoviableandprofitableprivatesectorinitiatives,andtochannelthemtoprojectsthatplayamajorroleinstructuraltransformation.Atthesametime,vitalpublicinvestment,inparticularattheearlystagesofcatchingup,needstobeprotectedbyconcertedinternationalactionstotackletaxavoidance,evasionandcapitalflightthaterodeStatesrevenuebase.

Thissaid,long-termandsustainable(externalanddomestic)financingrequires,firstandforemost,thatsystemicshortcomingsintheinternationalfinancialsystembetackledinsubstantialandlastingways.Italsorequiresresponsiblemacroeconomicpolicycoordinationamongcountries.Withoutreliablemacroeconomicstabilityandafullrecoveryindevelopedeconomies,long-termcorporaterealinvestmentwillcontinuetosufferindevelopedanddevelopingeconomiesalike.

Industrial policy redux

No country has made the arduous journey from widespread rural poverty to post-industrial prosperity withoutemployingtargetedandselectivegovernmentpoliciesthatseektoshifttheproductionstructuretowardsnewtypesofactivitiesandsectorswithhigherproductivity,betterpaidjobsandgreatertechnologicalpotential.Suchpoliciesareconventionallycalledindustrialpoliciesthoughtheymightbemoreaccuratelydescribedasproductiontransformationpolicies.

Agreatdealhasbeenwrittenaboutindustrialpolicytoolsandexperiencesinrecentdecades,withmuchofthediscussionrevolvingaroundasteriledebateaboutwhetherornotgovernmentscanpickwinners.Inrealityallpolicydecisionsinvolvepriority-setting,trade-offsandbargaining;andpolicymakersaredoomedtotarget.Thefocusofdiscussionneeds,instead,tobeonthechallengeoflinkage-buildinginsupportofvirtuousdevelopmentcircles,theintegratedpolicyapproachthisimplies,andtheinstitutionalgeometrythatisneededtoimplementthatapproach.

Giventhatamuchlargerlevelofinvestmentisrequiredforeconomictransformation,andthefactthattherehasbeenaweakeningoftheexport-investment-profitnexusanexusthatprovedcrucialtothesuccessoftheEastAsianlatedeveloperscatch-upgrowthstrategiesfaceenormouschallenges.Thisnecessitatesaseriousrethinkingofeconomicpolicyapproachesandoptions.

Inlightofthechangesintheglobaleconomy,governmentsindevelopingcountriesneedtobeambitiousbutnotunrealistic.Theyshouldstriveforahighdevelopmentroadbycreatingnewsourcesofgrowthanddynamism,ratherthansimplytryingtodothebestwithwhattheycurrentlyhavebytakingadvantageof

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existingcomparativeadvantages.Smallandincrementalstepscanbeuseful,butmoreradicalcomparative-advantage-defyingmeasureswillbeneededtoshifttowardshighervalue-addedandemployment-generatingactivitieswith high income elasticities andmore capacities for creating synergies through knowledgecreation.Thedownsideofaiminghighistoruntheriskoffailure.Thisriskshouldalsobemanaged,withmechanismsformonitoringperformance,observingunderperformance,andeitherrectifyingorremovingStateassistance.Accordingly,theemphasisbecomesnotonwhethertohaveanindustrialpolicyatall,butonhowtodesignandimplementitproperly.

Theroleandeffectivenessofindustrialpolicyisnotonlyaconcernindevelopingeconomies.WhiletheshareofindustrialactivityindevelopedeconomiesGDPhasbeendecliningforsomedecadesaspartoftheirevolutiontowardsapost-industrialsociety,thepaceandextentofthisshift,whichacceleratedintheearly2000s,hasbeguntoworrypolicymakersinseveraldevelopedeconomies.Suchworries,andattendantconcernsaboutthehollowingoutofthemiddleclassintheseeconomies,haveintensifiedsincethe2008globalcrisis,reinforcingtheargumentthatpolicymakersshouldnowuseindustrialpoliciesaspartofarebalancingoftheeconomyawayfromthelopsideddominationofthefinancialsector.ItisanargumentsupportedbytheslowrecoveryoftheseeconomiessincetheGreatRecession.

Inthiscontext,adistinctioncanbeusefullydrawnbetweenpassiveandactiveindustrialpolicies.Passivepoliciesessentiallyaccepttheexistingendowmentsandinstitutionalstructuresandaimtoreducethecostsofdoingbusiness, includingcoordinationand transactioncosts.Bycontrast, activepoliciestargetdeeperchangesincorporatestructureandbehaviour,suchasinvestment,exportingandupgrading.Theinstitutionalprerequisitesforactiveandpassivepoliciesarelikelytobedifferent.Inparticular, theeffective targetingofactivemeasures requiressubstantialStatecapacityandadegreeofdiscipline thatisoftenneglectedindiscussionsofindustrialpolicy.Inpractice,whileanactivepolicyisalmostalwaysaccompaniedbyapassivepolicy,thereverseisnotthecase.

Active industrial policies require a supportive institutional geometry of developmental States,government-business dialogue, and reciprocal controlmechanisms that ensure government supporttranslatesintodesiredactionsbytheprivatesector.Arguably,thecriticalstepandoftenamisstepintheapplicationofindustrialpoliciesistheprovision,monitoringandmanagingofrentsinsupportofstructuraltransformationandupgrading.Fromapolicyperspective,potentiallygrowth-enhancingrentscanbecomegrowth-reducingiftherentmanagementcapacitiesoftheStatearemissing.IftheStatedoesnothavethecredibilitytowithdraworwithholdfinancialsupportincasesofunderperformance,therewillnotonlybeshort-termcosts,butalsolong-termadverseconsequences.

ThekeyliesintheStateseffortstohelpbuildthelinkagesthatcansustainaprocessofstructuraltransformation,guiding resources towardsactivities thathave thepotential to increaseproductivityandhigherpayingjobs.Inmanycountries,thiswillinvolveexaminingallthedomesticsupplychainsacrosssectors,fromthestageofprimaryproductiontofinaloutputlogisticsofmanufacturingfirms.Inothers,itwillinvolvelinkingupwithglobalsupplychainsthatalreadyexist.Ineithercaseitwillinvolvefacilitatingaccesstolong-terminvestmentfinanceatreasonablecostformanufacturingfirms,especiallyintargetedsectors,aswellasinthoseactivitiesthatcanbenefitfromlinkageswithfirmsinthosesectors.Assuch,thetoolsandleversofindustrialpolicyshouldalsobepartofanintegratedandinterconnectedpackageofpoliciesthataligntrade,competition,labourandmacroeconomicpolicieswithindustrializationimperatives.Thepackageneedsalsotobeadaptable,changingwhenconstraintsandcapacitieschange.

Todayspolicymakerscannolongerrelyonexport-ledmanufacturingalonetogeneratethekindofgrowthachievedbytheEastAsianlateindustrializers.Thisisnottosaythatcountriesshouldstopseekingexportmarkets;rather,theyshouldrecognizethatamuchmorenuancedandstrategicapproachisneeded.Theyneedtobemorepragmaticintheirchoicesofproductsandoverseasmarkets,whilealsopayingcloserattentiontobuildingdomesticandregionalmarketsandtofosteringthevarietyofproduction,technologyandincomelinkagesthatanexpansionofthesemarketswillrequire.

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MukhisaKituyi Secretary-GeneralofUNCTAD

Inordertopromoteastructuralshift towardsmanufacturingandindustrializationor towardsmoresophisticatedservices,governmentsneedtoadoptpolicieswiththefollowingobjectives:

Ensurehighlevelsofaggregatedemand,highlevelsofinvestment,andastableexchangerate(whichmayonoccasionallowundervaluationbutnotovervaluation).Supportivefiscalpoliciesareimportanttocreatestablebutexpansionaryeconomicconditionsinwhicheconomicdiversificationcanflourish.

Cultivatethecapabilitiesneededtochangethecompositionandsophisticationofproductionactivities,andpromoteastronglearningenvironment.PublicR&Dislikelytobecritical,alongwithinvestmentinbothformaleducationalinstitutionsandinshop-floortraining.

Pursueintermediateinputsubstitutionindustrialization,particularlyinmiddle-incomecountriesthathaveenteredGVCsbutarestrugglingtoupgradetheirindustrialcapacities.Thiswillalsolikelymeantransformingexportprocessingzonesintomoreintegratedindustrialdevelopmentparkswithmuchstrongerbackwardandforwardlinkagestotherestoftheeconomy.

Avoidadoptingexportstrategiesthatrelyoncompressingwages;labourisnotjustacostofproduction,butanimportantsourceofdemandandtaxrevenue.

Promotedevelopment-orientedcompetitionrules,thatcanoffsettheglobaldominanceofMNEs.Thecombinationofincreasingconcentration atthetopofGVCsandincreasingcompetition at the bottom mayrequireanewinstitution,suchasaGlobalCompetitionObservatory, tomonitor trendsalongdifferentsegmentsofthevaluechainsandacrosssectors,andtoensurethatfirmsoutsideGVCsarenotunfairlyaffected.

Bolsteraccesstofinanceforstructuraltransformation,notonlyintermsofsupportingparticularlinesofinvestment,butalsoasausefulvehicleformonitoringandinfluencingcorporatebehaviourinsupportoflong-termdecision-making.Financialregulationcanpromoteindustrializationbymakingpurelyfinancialtransactionslessattractivethanother,moreproductiveinvestments.

Closetaxloopholesthroughfiscalandregulatorymeasuresatthenational,regionalandinternationallevels, and require greater transparency in corporate decision-making. Effective regulation ofdistortionarymonopolisticpracticesisessentialtoensurethatprofitsaredirectedtowardsproductiveinvestment.

MoreambitiousandcomprehensivepolicyactionintheseareaswillbeessentialformeetingthenewSustainableDevelopmentGoals.AsdiscussedinpreviousReports,anddespitethecurtailmentofpolicyspaceunderfinance-ledglobalization,thereisstillsufficientspacetopursuethekindofeconomicprogrammesthatcantriggertransformationalchangebutalsomoreinclusiveandsustainableoutcomes.However,thatspaceneeds tobebuttressedagainst the ideologicaland institutionalpressures thathaveplacedmarketefficiencyabovesharedprosperity.

Current Trends and Challenges in the World Economy 1

Theworldeconomyin2016isinafragilestate,withgrowthlikelytodipbelowthatregisteredinboth2014and2015.Themediocreperformanceofdevel-opedcountriessincethe20082009economicandfinancialcrisisissettocontinue,withtheaddedthreatthatthelossofmomentumindevelopingcountriesoverthepastfewyearswillbegreaterthanpreviouslyanticipated.Withoutachangeofcourseintheformer,theexternalenvironmentfacingthelatterlookssettoworsenwithpotentiallydamagingconsequencesfortheir prosperity and stability in the short to medium run.Morewidespread contagion fromunforeseenshockscannotberuledout,knockingglobalgrowthbackevenmoresharply.ThedecisionbytheUnitedKingdomelectorate to leave theEuropeanUnion(EU)issuchashock.

GrowthintheUnitedStatesthisyearislikelyto slow down, as themomentum thatwas builtthroughthequickdetoxificationofitsbankingsys-temandamoreaggressiveuseofmonetarypolicylosestraction.Unemploymenthasdroppedsteadilytothelevelregisteredbeforethecrisishitandrealearningshavebeguntopickup.However,givenitsweakunderlying employment rate, the number ofdistressedhouseholdswithhighlevelsofdebtandexportersstrugglingwithastrongdollar, therearenoguaranteesthattheeconomywillenjoyarobustperiodofgrowthanytimesoon.

RecoveryintheeurozonehaslaggedbehindthatoftheUnitedStates,inpartbecauseofthemoretimiduseofmonetarypolicybutalsoverytightfis-calstancesinsomecountries.Thetentativepick-upofgrowthfrom2015seemslikelytostallthisyear,and could even be reversed due to the uncertainty triggeredbytheannounceddepartureoftheUnitedKingdomfromtheEU(Brexit).Economicgrowthcontinuestobeheldbackbyweakdomesticdemandandonlysporadicsignsofanimprovementinrealwages.Effortstotacklethesharplydivergingeco-nomicperformancesofthecountriesintheeurozonearecomplicatedbypoliticaluncertainties,suchastheongoingmigrationcrisis,anddoubtsaboutthefuturepaceanddirectionofEuropeanintegration.

Europeaneconomiesoutsidetheeurozonehaveperformed better in recent years,mainly becausethe monetary authorities in many of those countries havebeenwilling,andable,toorchestratefinancialbubbles.TheeconomyoftheUnitedKingdom,evenwithout the threat ofBrexit, is set for a difficultperiodaheadgivenitslevelsofindebtednessandapersistentlyhightradedeficit.Thelongertermcon-sequencesoftheleavevotearestillunclear,giventhe unprecedented nature of the decision and the politicaluncertainty it has created, thoughgrowthwillundoubtedlyslowin theshort term.Justhowsteepthedropcouldbe,giventhehighlyfinancialized

Chapter I

CURRENT TRENDS AND CHALLENGES IN THE WORLD ECONOMY

A. A year of living dangerously

Trade and Development Report, 20162

andflexiblemarketsintheUnitedKingdom,isdif-ficulttopredict.

Japan continues to exhibit a distinct set ofeconomic characteristics that have emerged fromdecadesofunderperformance,withpersistentlylowanderraticgrowthaccompaniedbyalowunemploy-mentrate(currentlyaround3percent),ahugelevelof domestic debt and a strongpayments position.However,likeotherdevelopedeconomies,Japanhasseentheshareofwagesinincomedropsignificantlyoverthepastfewdecades(registeringamongstthelargestdeclinesin