April-- June 1996
Volume 7, Number2
The pace of global economic integration --- the widening and intensifying of international linkages in trade and finance --- has accelerated over the past decade. During 1985 - 94 the ratio of world trade to GDP rose three times faster than in the preceding 10 years and nearly twice as fast as in the 1960s. Over the same period foreign direct investment doubled as a share of global GDP.
Developing countries have been a big part of this trend of growing integration. Overall, their trade to GDP ratio rose as fast as that of industrial countries, and their share of global foreign direct investment rose from about a fifth to two-fifths. But there are wide disparities in both rates of growth and integration across developing countries. Some have even become less integrated with the global economy.
Integration matters because there is an association between growth and integration. Fast growth tends to promote a more open economy, reflecting policies common to both, and thus lagging integration is often a sign of underlying policy deficiencies. In addition, integration tends to promote higher growth, through the channels of better resource allocation, greater competition, transfer of technology, and access to foreign savings.
Policies found to have a strong bearing on the pace of integration include macroeconomic policies, trade reform, and the provision of physical infrastructure. Macroeconomic stability --- reflected in, for example, the size of fiscal deficits and the volatility of the real exchange rate --- shows a close empirical positive relationship with integration. This suggests that the right macropolicies not only are good for growth and inflation, but also help to facilitate an outward orientation.
Although developing countries in the aggregate kept pace with the world rate of trade growth, the ratio of trade to GDP actually fell in some 44 of 93 developing countries observed over the past 10 years. Another 17 countries experienced only moderate rises. In fact, three-quarters of the remarkable increase over the past decade was accounted for by just 10 countries.
Although the developing countries' share of foreign direct investment increased to 38 percent of the world's total, two-thirds of these flows went to just eight developing countries; half received little or none. This trend is likely to continue unless policies are changed. Trade and investment will accelerate in countries that have opened up to the global economy. The prognosis for those that fail to integrate is poor, and the divisions between the integrated and isolated countries will continue to widen.
The analysis here uses a speed of integration index derived from changes between the early 1980s and the early 1990s in four indicators: the ratio of real trade to GDP, the ratio of foreign direct investment to GDP, Institutional Investor credit ratings, and the share of manufactures in exports. The speed of integration index is the simple average of changes in the four indicators over the period (each expressed as a standard deviation from its average).
On the basis of this index, developing countries are grouped in four categories ranging from "fast integrators" to "slow integrators." This classification is not intended to derive a precise categorization of individual countries. Instead, its purpose is to develop evidence about the factors that might account for large differences in the speed of integration among groups of countries, and the consequences of this for performance.
Most of the fast-growing East Asian exporters were among the fast integrators as a result of exceptionally large increases in trade, manufactures exports, and foreign direct investment ratios. This group also contains reformers, such as Argentina, Chile, and Mexico in Latin America; Morocco in the Middle East; Ghana and Mauritius in Sub-Saharan Africa; and the Czech Republic, Hungary, Poland, and Turkey in Europe. The concentration of transition economies in this group and in the category of moderate integrators results from the marked rise in these countries' trade shares, foreign direct investment inflows, and credit ratings after the fall of communism.
South Asian countries are concentrated in the categories of fast or moderate integrators but still have much potential for further integration. Bangladesh, India, and Pakistan had average tariffs in the early 1990s of 50 percent or more. Among other Asian countries, China had average tariffs of around 40 percent. Nontariff barriers in some of these countries were also high.
The weak and slow integrators include not only most of the low income countries in Sub-Saharan Africa but also many middle-income countries in Latin America and the Middle East and North Africa.
• Trade ratios advanced strongly in some regions in the past 10 years, though they fell in Sub-Saharan Africa, were flat in the Middle East and North Africa, and barely edged forward in South Asia (figure 1). Overall, trade ratios fell in 44 of 93 developing countries, representing more than one billion people, or 26 percent of the population in these 93 countries.
Levels of and changes in tariffs also vary widely across developing regions. Tariff levels matter because high levels of protection can seriously impair growth. Tariffs in South Asia, averaging around 45 percent in the early 1990s, remain far higher than those in other regions, despite substantial falls, while those in the Middle East and North Africa and Sub-Saharan Africa, in the 25 - 30 percent range, have shown little change since the second half of the 1980s. But several transition economies in Central and Eastern Europe have achieved average tariffs of about 10 percent, while rates in Latin America and East Asia (excluding China) are down to around 15 percent.
• The distribution of foreign direct investment across developing countries is also highly skewed (figure 2). Eight countries that account for 30 percent of developing country GDP garnered two-thirds of all foreign direct investment flows in 1990 - 93. For half the 93 developing countries reviewed, foreign direct investment inflows were less than 0.25 percent of their GDP during 1991 - 93. Regions with particularly low ratios of foreign direct investment to GDP included South Asia, Sub-Saharan Africa, and the Middle East and North Africa.
• Country credit ratings generated by banks or rating agencies show wide disparities across developing countries, with many countries completely shut out of medium- and long-term private markets. Institutional Investor's recent ratings for 126 countries are divided into four equal ranges labeled, from best to worst, A through D. Such ratings are an important influence on the cost of funds in international markets.
More than 40 percent of the countries were in the lowest rating category. These include half or more of the countries in Sub-Saharan Africa, Latin America (chiefly in Central America and the Caribbean), and Europe and Central Asia (almost all states of the former Soviet Union). They also include nearly half the countries in the Middle East and North Africa, as well as Bangladesh, the Democratic People's Republic of Korea, Myanmar, Nepal, and Vietnam in Asia.
• The share of manufactures in exports may provide some information on countries' access to learning and to technology transfers and on their ability to produce at world standards. This ratio varies a great deal: two thirds of the 93 developing countries reviewed had a share of manufactures in exports of a third or less in 1983 - 92, and for half the share was less than 20 percent. Sub-Saharan Africa's share of manufactures in exports was less than 10 percent, while the Middle East and North Africa and Latin America and the Caribbean had average shares of 20 - 25 percent.
The high-income countries and fast integrators among the developing countries achieved median per capita GDP growth of about 2 percent a year over the past decade (figure 3). Moreover, the experience of the fast integrators was not merely a reflection of high-growth East Asian countries, although they are important. Excluding East Asian countries, fast integrators still achieved median per capita growth of 1.5 percent a year, well above growth rates in the other classes of integrators. Median incomes fell among the other groups of integrators, with the largest declines occurring among the weak and slow groups. There was also a strong association between growth in 1984 - 93 and the level of integration at the beginning of the period (figure 4). But high initial levels of integration are relatively independent of high speeds of integration.
Countries with better integration performance enjoyed not only higher but also more stable growth: the median standard deviation of per capita GDP growth among fast integrators was a little over half as high as that among the weak and slow integrators.
The positive effect of freer trade and foreign investment on growth is one factor explaining the relation between integration and growth. Simply put, such factors as technology transfer and learning, improved resource allocation, greater competition, and access to foreign capital help countries grow. But this is only one part of the interaction between integration and growth. Growth itself tends to promote integration. Imports rise faster than incomes as consumers satisfy their desire for diversity. The rising returns to capital associated with faster growth raise developing countries' capital goods imports. Fast-growing countries attract more foreign direct investment and obtain better credit terms. East Asia most clearly illustrates how rapid growth tends to project countries onto regional and world markets, while lack of growth, as in Sub-Saharan Africa, leads to marginalization in world goods and capital markets.
The close association between growth and the speed of integration also suggests that both are likely to be affected by several common factors, including changes in the external environment, the evolution of the institutional setting, and the policies pursued by governments.
Fourth Annual World Bank
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