The 1990s are off to a slow start. Economic growth in the G-5 economies fell from 3.3 percent in 1989 to 2.7 percent in 1990 (table 1), inflation continued to edge upward, the fiscal deficit in the United States remained stubbornly high, and symptoms of financial stress in U.S. and Japanese banks became increasingly evident.
But the recession in the United States appears to have ended as slimmer inventories, declining oil prices, a depreciating dollar, and lower interest rates are restoring the momentum of demand. A stronger U.S. economy, together with a recovery in the United Kingdom and France, is expected to raise the G-5 growth rate to 2.7 percent in 1992. Although the recent slowdown in industrial countries is not in itself likely to damage long-run prospects in developing countries, it has increased the difficulty of dealing with the more serious structural issues facing the global economy.
For the longer term, the Bank's recent Global Economic Prospects examines scenarios based on alternative assumptions about the quality of international economic management and uses model-based results to derive consequences for industrial and developing countries.
Its baseline forecast incorporates a menu of feasible and appropriate adjustments to the present tensions in the world economy. Under this scenario, the G-5 economies grow at almost 3 percent a year on average in the 1990s, close to the level in the 1980s. Real interest rates average 370 basis points, and labor productivity grows 2 percent a year. The U.S. economy, after a slow start, rebounds to 2.9 percent GNP growth in the second half of the decade. Europe performs better than it did in the 1980s, stimulated by German unification and the creation of a single market in the European Community. And Japan maintains steady growth of 3.7 percent a year, somewhat below the 4 percent rate of the 1980s. However, the analysis of alternative scenarios points to a preponderance of downside risks, with the result that the expected mean values of key economic indicators are less favorable than those of the baseline forecast (table 1).
For developing countries, the baseline scenario incorporates external circumstances for development that are, on the whole, moderately better than in the "lost decade" of the 1980s. World trade is expected to grow a little faster, and the real interest rate to be a little lower. But the terms of trade for primary producers will be considerably worse on average. What is more, the 1990s started poorly for developing countries, with GDP per capita barely rising in 1990. Nevertheless, with improved domestic policies and a supportive international trading environment, developing countries could expect their growth to average about 3 percent per capita in the 1990s, up from 1.6 percent in the 1980s (table 2).
But to support this acceleration in growth, imports of developing countries would need to grow significantly faster than output to recover from the severe compression of imports because of the debt crisis during the 1980s. This need would be particularly strong for the severely indebted middle-income countries. Faster import growth, in turn, would need to be supported by effective debt relief measures, open industrial country markets for the exports of developing countries, and strong domestic policy measures in developing countries to promote exports and attract export-oriented foreign direct investment. The resulting higher levels of real net imports of goods and nonfactor services, when sustained over the decade, would also contribute toward reducing the number of poor people in developing countries from 1.1 billion in 1985 to 825 million in the year 2000.
The growth of individual developing countries has varied widely in the past because of differences in economic policies and resource endowments. Yet the growth rate of developing countries as a group has tended to move closely with the growth rate of industrial countries (see box 1). This reflects strong links between the industrial and developing economies, through international trade, interest rates, capital flows, and commodity prices. The outcomes at the global level in these four areas will have a significant bearing on the growth prospects of developing countries through their effect on the growth of industrial country markets, the international cost of capital, the terms of trade, and the availability of external capital, particularly export-oriented foreign direct investments.
OECD growth. A one percentage point a year increase in OECD growth could boost the growth rate of developing countries by as much as 0.7 percentage point. But this effect would vary by region. For example, Sub-Saharan Africa would benefit relatively little from higher growth in industrial countries because the income elasticities of demand for its exports are low and because the erosion of export capacity during the 1980s reduced its ability to respond to increased external demand. In contrast, East Asia's diversified industrial base and large capital goods exports make the region's economic performance particularly sensitive to the health of industrial economies.
Real interest rates. nternational real rates of interest are also important to developing countries, especially to those holding large volumes of external debt at variable interest rates. Simulations suggest that every one percentage point increase in real LIBOR (the London interbank offered rate) could reduce the growth rate of developing countries as a group by as much as 0.2 percentage point a year. For severely indebted countries, it could mean that growth is reduced by as much as 0.4 percentage point a year (table 3).
Terms of trade. Groups of developing countries differ greatly in their exposure to terms of trade risks. For example, exporters of manufactures are likely to face terms of trade that remain essentially unchanged during the 1990s. For this group, the broad product composition of exports is nearly the same as that of imports, providing a natural hedge against terms of trade risk. This result contrasts most sharply with the outcome for low-income Africa (excluding Nigeria), where the terms of trade risk is not only large but skewed downward.
Capital flows. The fourth risk to developing countries is the availability of external capital. Should external circumstances improve, it would tend to mean more external financing (and larger external current account deficits) for developing countries, although the aggregate debt service ratio would fall. The bulk of the additional finance will need to come from private sources, including foreign direct investment. In Latin America and East Asia---and to less extent, Europe, the Middle East, and North Africa---the scale of foreign direct investment and other private flows will be sensitive to the state of the world economy in the 1990s. By contrast, Sub-Saharan Africa relies on official development assistance, and its global supply is likely to remain fairly rigid. Thus, the composition of Africa's sources of external finance reinforces the composition of its production, exports, and debt in limiting Africa's growth opportunities in the medium term.
Scenarios around this baseline show the sources and magnitude of uncertainty in the 1990s and suggest how and why different groups of countries could be affected. The downside scenario takes a less sanguine position than the base case, asking what would happen if various adjustments to present tensions (even though feasible and appropriate) were not accomplished. And the outer flanks of the probability distribution are explored through low and high scenarios, identifying the extremes of what is here called the management dimension in the world economy.
The low-case scenario examines the possibility that greatly amplified uncertainties and turbulence in both international trading and financial systems may lead to a much higher level of real interest rates, stagnation in industrial countries, high and unstable oil prices, continued declines in real nonoil commodity prices, and continued inertia in private financial flows to developing countries. In such circumstances, the chances are high that structural adjustment programs in many developing countries would not be sustained.
At the other end of the spectrum is the high-case scenario, in which challenges confronting the world economy are met convincingly and successfully. This instills confidence and reduces uncertainty in international markets, spurring further integration of the global economy. International prices of importance to developing countries---real interest rates, exchange rates, real commodity prices---are predictably stable, and investors have confidence that long-run environmental and demographic concerns are being taken in hand. The real cost of borrowing declines and real commodity prices rise in this case, promoting economic convergence among developing countries and between developing and industrial countries.
The plausible range of growth estimates for developing countries in the 1990s is therefore wide: from less than 3 percent a year to well over 6 percent. This range translates into a 40 percent difference in the level of real income by the year 2000.
The alternative global scenarios suggest that the divergent growth in the 1980s will continue into the next decade (see box 2). Global forces---the level and composition of economic activity, the openness to trade, appropriate financial flows, and transfers of technology---will continue to influence development prospects in the aggregate. This is true even though the prospects for individual countries will be governed primarily by how well each uses its own resources, and so by the quality of its own policy design and implementation.
Policy in the industrial countries also has implications for the prospects of developing countries. A policy mix that places greater reliance on monetary rather than fiscal policy may be less favorable to developing countries if it leads to higher interest rates or disruptive swings in exchange rates. In recognition of the close interdependence between industrial and developing countries, governments, whether in national or multilateral settings, clearly need to take account of developing country concerns when formulating policies that will affect the world economy.
From World Bank, Global Economic Prospects and the Developing
Countries, Washington, DC, 1991 (available from World Bank
Publications---order stock #11838/$10.95).