The Global Economy Without Steroids

Read Time:4 Minute, 2 Second, DC – Economic growth is back. Not only are the United States, Europe,
and Japan finally expanding at the same time, but developing countries are also
regaining strength. As a result, world GDP will rise by 3.2% this year, up from 2.4%
in 2013 – meaning that 2014 may well be the year when the global economy turns the

The fact that the advanced economies are bouncing back is good news for everyone.
But, for the emerging and developing economies that dominated global growth over the
last five years, it raises an important question: Now, with high-income countries
joining them, is business as usual good enough to compete?

The simple answer is no. Just as an athlete might use steroids to get quick results,
while avoiding the tough workouts that are needed to develop endurance and ensure
long-term health, some emerging economies have relied on short-term capital inflows
(so-called “hot money”) to support growth, while delaying or even avoiding difficult
but necessary economic and financial reforms. With the US Federal Reserve set to
tighten the exceptionally generous monetary conditions that have driven this “easy
growth,” such emerging economies will have to change their approach, despite much
tighter room for maneuver, or risk losing the ground that they have gained in recent

As the Fed’s monetary-policy tightening becomes a reality, the World Bank predicts
that capital flows to developing countries will fall from 4.6% of their GDP in 2013
to around 4% in 2016. But, if long-term US interest rates rise too fast, or policy
shifts are not communicated well enough, or markets become volatile, capital flows
could quickly plummet – possibly by more than 50% for a few months.

This scenario has the potential to disrupt growth in those emerging economies that
have failed to take advantage of the recent capital inflows by pursuing reforms. The
likely rise in interest rates will put considerable pressure on countries with large
current-account deficits and high levels of foreign debt – a result of five years of
credit expansion.

Indeed, last summer, when speculation that the Fed would soon begin to taper its
purchases of long-term assets (so-called quantitative easing), financial-market
pressures were strongest in markets suspected of having weak fundamentals. Turkey,
Brazil, Indonesia, India, and South Africa – dubbed the “Fragile Five” – were hit
particularly hard.

Similarly, some emerging-market currencies have come under renewed pressure in
recent days, triggered in part by the devaluation of the Argentine peso and signs of
a slowdown in Chinese growth, as well as doubts about these economies’ real
strengths amid generally skittish market sentiment. Like the turbulence last summer,
the current bout of market pressure is mainly affecting economies characterized by
either domestic political tensions or economic imbalances.

But, for most developing countries, the story has not been so bleak. Financial
markets in many developing countries have not come under significant pressure –
either in the summer or now. Indeed, more than three-fifths of developing countries
– many of which are strong economic performers that benefited from pre-crisis
reforms (and thus attracted more stable capital inflows like foreign-direct
investment) – actually appreciated last spring and summer.

Furthermore, returning to the athletic metaphor, some have continued to exercise
their muscles and improve their stamina – even under pressure. Mexico, for example,
opened its energy sector to foreign partnerships last year – a politically difficult
reform that is likely to bring significant long-term benefits. Indeed, it arguably
helped Mexico avoid joining the Fragile Five.

Stronger growth in high-income economies will also create opportunities for
developing countries – for example, through increased import demand and new sources
of investment. While these opportunities will be more difficult to capture than the
easy capital inflows of the quantitative-easing era, the payoffs will be far more
durable. But, in order to take advantage of them, countries, like athletes, must put
in the work needed to compete successfully – through sound domestic policies that
foster a business-friendly pro-competition environment, an attractive foreign-trade
regime, and a healthy financial sector.

Part of the challenge in many countries will be to rebuild macroeconomic buffers
that have been depleted during years of fiscal and monetary stimulus. Reducing
fiscal deficits and bringing monetary policy to a more neutral plane will be
particularly difficult in countries like the Fragile Five, where growth has been

As is true of an exhausted athlete who needs to rebuild strength, it is never easy
for a political leader to take tough reform steps under pressure. But, for emerging
economies, doing so is critical to restoring growth and enhancing citizens’
wellbeing. Surviving the crisis is one thing; emerging as a winner is something else

Sri Mulyani Indrawati, Indonesia’s former finance minister, is Managing Director
and COO of the World Bank.

source: Project Syndicate

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