By Michael Spence and Sandile Hlatshwayo
NEW YORK – Since World War II’s end, the global economy’s trade and financial openness has increased, thanks to institutions like the International Monetary Fund and successive rounds of liberalization, starting with the General Agreement on Tariffs and Trade (GATT) in 1947. In parallel, colonialism collapsed, and we are now slightly more than halfway through a century-long process of modernization for the many developing countries that emerged. But where has that process led, where is it taking us now, and, perhaps most importantly, how can we influence its course?
With formal barriers to trade and capital flows lowered, several trends combined to accelerate growth and structural change in post-colonial and other developing economies. These included advances in technology (especially in transportation and communications), management innovation in multinational companies, and integration of these companies’ supply chains.
Thus, in the early post-war period, developing countries, whose exports had previously consisted mainly of natural resources and agricultural products, expanded into labour-intensive manufacturing. Textiles and apparel came first, followed by luggage, dishes, toys, etc. Supply chains also dispersed geographically, with lower value-added components and processes allocated to low-income countries.
In consumer electronics, for example, low-income countries became a natural location for labor-intensive assembly processes. But semi-conductors, circuit boards, and other components were designed and manufactured in high middle-income countries like Korea.
Although the shifting structure of the global economy is best described as a journey taken only once, growth in developing countries does exhibit repeating patterns. Powerful economic forces drive the structural evolution and economic diversification that underpin growth, producing transitions that have common elements.
For example, after more than 30 years of rapid growth, China is entering a “middle-income transition.” Over time, labor-intensive components of value-added chains will move away from China’s higher-income areas. Helped by massive public investment in infrastructure and logistical capabilities, some of this work will move inland, where incomes are lower. Eventually, however, labor-intensive activities will move to countries at earlier stages of development, while China moves up the value chain, both in the export sector and, with rising incomes, in production for domestic consumption.
But this middle-income transition is sometimes deemed a trap. Indeed, most countries entering middle-income transitions see their growth slow, even stall. Of the 13 post-war cases of sustained high growth (soon to be 15, with the addition of India and Vietnam), only five economies – Japan, Korea, Taiwan, Hong Kong, and Singapore – have maintained high growth rates through the middle-income transition and proceeded toward advanced-country income levels of $20,000 per capita or above.
All of this structural change is part of a constantly shifting global economic landscape whose aggregate pattern is not perfectly predictable, in part because countries enter and engage with the global economy at different times and expand at different rates. Early high-growth economies – Japan, South Korea, Taiwan – initially exported labor-intensive products, then graduated to more capital-intensive goods like motor vehicles, and then to human-capital-intensive activities like design and technology development. As wages rose, Japan’s old labor-intensive activities migrated to later arrivals in the global economy.
China accelerated to a high-growth pattern in the late 1970s and early 1980s, owing to the benefits of its low-cost labour and a major change in economic policy. But no one anticipated China’s abrupt shift away from a closed, centrally planned economy to a more open, market-oriented one with expanded economic freedom for individuals and enterprises alike.
As emerging-market economies shift to higher value-added components in global supply chains, their physical, human, and institutional capital deepen. This brings their structure closer to that of the advanced countries, introducing greater competition in what was once the advanced countries’ sole territory – the most sophisticated of value-added goods and services.
At this point, countries arrive at a crossroads. The aggregate size of the developing countries (especially the major emerging economies), their rising incomes, and their ongoing movement up the value chain are having a growing impact on advanced-country economies, particularly these economies’ tradable sectors.
What is the impact on a large advanced country like the United States? Some 98% of the 27.3 million net new jobs created in the US since 1990 have been in the non-tradable sector – dominated by government, health care, retail, hospitality, and real estate. Given long-term constraints on both fiscal and household spending in the wake of the financial crisis and downward pressure on asset prices, the sustainability of such an employment trend is questionable.
Indeed, the post-crisis shortfall in domestic demand is causing stubbornly high unemployment, even as the economy recovers some of its growth momentum. In principle, foreign demand, especially in high-growth emerging markets, could make up some of the difference. But that has not happened – at least not yet. Although the US trade deficit fell to $375 billion in 2009, from $702 billion in 2007, the adjustment came entirely from a sharp decline in imports, from $2.35 trillion to $1.95 trillion, whereas exports actually fell slightly, from $1.65 trillion to $1.57 trillion.
Growth in exports could come with further expansion in parts of the value-added chains where the US is already competitive (finance, insurance, and computer systems design, for example). But the scope of the export sector itself will have to expand in order to generate sufficient employment and reduce the external deficit.
That will require restoring and creating competitiveness in an expanded set of value-added components in the tradable sector. It would be nice if there were an easy and reasonably certain way to accomplish that. But there isn’t, and protectionism is certainly not the answer. It is a complex challenge for any country, one that calls for a multi-pronged approach to heightening investment in human capital, the technological base of the economy, and infrastructure.
