Growth in developing economies and their increasing integration into world trade and finance benefit, rather than hurt, industrial countries
As developing countries increasingly become part of the global economy, they benefit not just themselves but also industrial countries. The gains to industrial countries from reverse linkages are potentially huge. There are, however, a couple of caveats.*
Much depends on developing countries' continuing the policy improvements responsible for their rapid economic growth in recent years (see figure 1). Many face political and policy uncertainties, and the path forward is unlikely to be smooth. Witness Mexico's woes. Much also depends on the continuing liberalization of global trade---and that cannot be taken for granted, given the strong protectionist pressures in both industrial and developing countries.
The gains from reverse linkages come from increased trade integration of developing and industrial countries, increased integration through financial flows, and higher growth in developing countries. Closer integration has some costs for industrial countries, but these are far outweighed by the benefits.
In 1994 developing countries' share of world imports was 24%. That could rise to 30% or so by 2010. At the same time, their share in world exports of manufactures could increase from 17% to more than 22%. Developing countries purchase roughly a quarter of industrial country exports and, on present trends, that could rise to more than a third by the end of the next decade.
One indicator of the potential gains from trade integration between industrial and developing counties is the price difference for similar products in those countries---the greater the difference the bigger the possible gains through trade. Cost-price differences between developing and industrial countries are on average about twice those between industrial countries. That suggests that (trade) specialization and efficiency gains to industrial countries from integration with developing countries will be greater than those from further trade integration among themselves.
Because of technology improvements, trade in long-distance services is also increasing. This trade is likely to bring big gains to industrial countries because the cost of providing services in developing countries is a fraction of that in industrial countries. For example, the gross dollar income of clerks in Bombay is one-fortieth that of clerks in Zurich. Little wonder that the Swiss national airline (Swissair) now has a sizable part of its back office in India.
Big price differences and faster growth of per capita income in some developing countries suggest that the dynamic gains from trade with them will be large. Increased trade integration can increase the rate of output growth in industrial countries. It can also mean higher productivity growth. It can, for example, raise the incentive to invest in research and development because firms can spread the fixed costs of R&D over a bigger market, which in turn could mean faster innovation and technical progress.
All the gains from trade integration will be reinforced by efficiency gains from increased globalization of industrial country production and distribution through foreign direct investment (FDI). Indeed, FDI plays a vital role in generating gains from trade integration; for example, more than 30% of trade between Mexico and the United States is intracompany sales.
In 1992Ð94 developing countries received about 40% of global FDI inflows, compared with 23% in the early 1980s. That share is likely to rise further as more developing countries open their markets and improve growth prospects.
Developing countries also offer investors in industrial countries pure financial gains from FDI. Over the past three years the rate of return on FDI flows from the United States to the rest of the G-7 has averaged around 8%, while returns on FDI flows to the eight largest developing countries averaged about 21%. Of course, that difference reflects the greater risk in the developing countries, but even the risk-adjusted rates of return in those countries are substantially higher than the returns in industrial countries.
Investments in shares traded on emerging stock markets also offer higher returns and help to diversify risk. The typical pension fund in the United States holds only 1Ð2% of its portfolio in emerging markets. Yet calculations for 1989Ð94 suggest that if industrial country investors were to increase this share to about 20% (assuming emerging markets could absorb such an inflow without appreciating substantially), the annual return on the entire portfolio would rise by 2 percentage points without increased risk.
On current trends, developing countries could account for 38% of the growth in world output in 1995Ð2010, compared with 22% in the 1980s. Their share of world output would rise from 21% in 1994 to 27% in 2010 (see figure 2). In terms of purchasing power parity, more than half of world output could come from developing countries in the next decade, compared with 43% today. By 2010 they would account for more than 55% of global consumption and capital formation (again, in terms of purchasing power parity). And three developing countries---China, India, and Indonesia---could be among the world's six biggest economies.
Growth in developing countries stimulates demand for industrial country output in two ways. With growth in investment, it boosts the demand for capital goods and services. And, as incomes rise, so too does the demand for more (and increasingly sophisticated) imports of consumer goods. By 2010 more than one billion consumers in developing countries could have per capita incomes exceeding those of Greece or Spain today.
Has increasing integration hurt industrial countries? Some, but not much. Certainly, it does not appear to have been an important factor in the decline in manufacturing in industrial economies over the past 20 to 30 years---nor in the rise in unemployment and wage inequality. But what of the future? As trade with developing countries continues to increase, some industries will shrink, others will expand. Most affected will be labor-intensive and low-skill industries. At the same time, those industries and services in which industrial countries retain comparative advantage will expand. For industrial countries, the challenge is to minimize the social costs of adjustment while reallocating resources to those industries that benefit from integration.
Flexibility in labor markets is crucial. When these markets work smoothly, any increase in unemployment can be kept to a minimum. In the 1980s, for example, the United States was able to generate 6 million jobs in the retail, hotel, and restaurant sectors, compared with the loss of 400,000 jobs (in textiles, leather, and apparel) that could be attributable to competition from developing countries.
Inevitably, there will be calls for more protectionism. Indeed, that is probably the biggest single threat to this mutually beneficial integration, and it must be resisted. If not, both developing and industrial countries will lose---and lose big.
* For more details, see World Bank, Global Economic Prospects and the Developing Economies 1995, Washington, DC, 1995.
