Supply side reforms are needed to increase resilience and lift productivity growth
Overall, while the prospects for developing countries are for solid if not spectacular growth, the path forward is not assured — as the sub-5 percent growth of the past few years attests. Many developing countries have privileged demand stimulus over structural reforms during the post crisis period. Reforms have stalled in recent years even as structural bottlenecks in energy and infrastructure (Brazil, India, South Africa), labor markets (India, South Africa) and business climate (Brazil, India, Russia, South Africa) have constrained GDP growth and productivity. Partially as a result, middle-income country growth has disappointed in the post crisis period.
The structural reform agenda needs to be reinvigorated in order to sustain rapid income growth. The contribution to potential output from capital accumulation, which has declined markedly in the post-crisis period is likely to ease further as capital costs rise and international liquidity tightens. Meanwhile, demographics have turned less supportive: aging populations imply that growth rates in many middle-income countries will slow as age-dependency ratios catch up to levels in advanced economies and working age populations grow more slowly These trends are most advanced in developing Europe and Central Asia, China and Thailand where demographic trends have already reached a turning point. Working age population growth is slowing in the rest of East Asia and in other developing regions too, with Sub-Saharan Africa a notable exception.
All this places a greater premium on policy reforms that raise productivity growth. Policymakers need to push ahead with reforms on a number of fronts, that include labor and product market and business regulation reforms that enhance competition. Financial market reform is key as well, including reducing the dominance of state-owned or controlled institutions. The relatively solid performance of Mexico and Philippines (who have undertaken recent policy reforms) and earlier reformers Chile, Poland and Peru during the recent episodes of global financial volatility reflects the increasing attention that financial markets are paying to developing-country fundamentals.
On the fiscal front, reforms are needed to raise the quality of public investments in human capital and physical infrastructure. One potential avenue for creating space for infrastructure and education spending is through subsidy reforms. Quantifying the benefits of subsidy reforms is hard, not least because these can be provided though off-balance sheet transactions. OECD (2009) suggests that subsidy reform can improve household welfare in countries where subsidies are particularly high and generate large distortions. Moreover, actual fiscal savings, although differing by countries, can be substantial even after compensating households for the removal of subsidies.