Prospect Group Policy Research Working Papers -- Recent Issues
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Potential Growth: A Global Database (March 2023)
Potential growth—the rate of expansion an economy can sustain at full capacity and employment—is a critical driver of development progress. It is also a major input in the formulation of fiscal and monetary policies over the business cycle. This paper introduces the most comprehensive database to date, covering the nine most commonly used measures of potential growth for up to 173 countries over 1981–2021. Based on this database, the paper presents three findings. First, all measures of global potential growth show a steady and widespread decline over the past decade, with all the fundamental drivers of growth losing momentum over time. In 2011–21, potential growth was below its 2000–10 average in nearly all advanced economies and roughly 60 percent of emerging market and developing economies. Second, adverse events, such as the global financial crisis and the COVID-19 pandemic, contributed to the decline. At the country-level also, national recessions lowered potential growth even five years after their onset. Third, the persistent impact of recessions on potential growth operated through weaker growth of investment, employment, and productivity.
Potential Growth Prospects: Risks, Rewards, and Policies (March 2023)
Potential output growth around the world slowed over the past two decades. This slowdown is expected to continue in the remainder of the 2020s: global potential growth is projected to average 2.2 percent per year in 2022–30, 0.4 percentage point below its 2011-21 average. Emerging market and developing economies (EMDEs) will face an even steeper slowdown, of about 1.0 percentage point to 4.0 percent per year on average during 2022–30. The slowdown will be widespread, affecting most EMDEs and countries accounting for 70 percent of global GDP. Global potential growth over the remainder of this decade could be even slower than projected in the baseline scenario — by another 0.2–0.9 percentage point a year — if investment growth, improvements in health and education outcomes, or developments in labor markets disappoint, or if adverse events materialize. A menu of policy options is available to help reverse the trend of weakening economic growth, including policies to enhance physical and human capital accumulation; to encourage labor force participation by women and older adults; to improve the efficiency of public spending; and to mitigate and adapt to climate change, including infrastructure investment to facilitate the green transition.
Trade as an Engine of Growth: Sputtering but Fixable (March 2023)
International trade has been an important engine of output and productivity growth historically. But since the global financial crisis, world trade growth has slowed, reflecting cyclical and structural forces. The COVID-19 pandemic and Russia’s invasion of Ukraine have further disrupted commodity markets, global supply chains and the trade that accompanies them. A removal of impediments that raise trade costs could reinvigorate world trade. Trade costs, on average, roughly double the cost of internationally traded goods relative to domestically sold goods. Tariffs amount to only one-twentieth of average trade costs; the bulk are incurred in shipping and logistics, and trade procedures and processes at and behind the border. Despite a decline since 1995, trade costs remain about one-half higher in EMDEs than in advanced economies; about two-fifths of this gap appears to be due to higher shipping and logistics costs and a further two-fifths due to trade policy. A comprehensive reform package to lower trade costs could yield large dividends. It is estimated that among the worst-performing EMDEs, a hypothetical reform package to improve logistics and maritime connectivity to the standards of the best-performing EMDEs would halve trade costs.
How Do Rising U.S. Interest Rates Affect Emerging and Developing Economies? It Depends (December 2022)
This paper examines the implications of different types of interest rate shocks in the United States for emerging market and developing economies (EMDEs). It first classifies changes in U.S. interest rates into those caused by changes in inflation expectations (“inflation” shocks), changes in perceptions of the Federal Reserve’s reaction function (“reaction” shocks), and changes in real activity (“real” shocks). The analysis attributes this year’s sharp increases in U.S. interest rates almost exclusively to inflation and reaction shocks. These types of shocks are found to be associated with especially adverse effects: EMDE financial conditions tighten, consumption and investment fall, and governments cut spending to improve budget balances. By comparison, rising U.S. interest rates stemming from real shocks are not only associated with benign outcomes for EMDE financial conditions but also improvements in budget balances that reflect higher revenues as well as lower expenditures. Finally, this paper documents that rising U.S. interest rates driven by reaction shocks are especially likely to push EMDEs into financial crisis.
From Financial Development to Informality: A Causal Link (September 2022)
Financial development reduces the cost of accessing external financing and thus incentivizes investment in higher-productivity projects that allow firms to expand to the scale needed to operate in the formal economy. It also encourages participants of the informal sector to join the formal sector to gain access to credit and financial services. This paper documents two findings. First, countries with less pervasive informality are associated with greater financial development. Second, the impact of financial development, and especially banking sector development, on informality is causal. This causal link is established using a novel instrumental variable for domestic financial development: financial development in other (neighboring) countries. The causal link between informality and financial development is stronger in countries with greater trade openness and capital account openness. The findings are robust to alternative specifications.
Demand and Supply Shocks: Evidence from Corporate Earning Calls (February 2022)
This paper quantifies global demand, supply, and uncertainty shocks and compares two major global recessions: the 2008–09 Great Recession and the COVID-19 pandemic. Two alternative approaches are used to decompose economic shocks: text mining techniques on earning call transcripts and a structural Bayesian vector autoregression model. The results highlight sharp contrast in the size of supply and demand shocks over time and across sectors. While the Great Recession was characterized by demand shocks, COVID-19 caused sizable disruptions to both demand and supply. These shocks were broad-based with varying relative importance across major sectors. Furthermore, certain sub-sectors, such as professional and business services, internet retail, and grocery/department stores, fared better than others during the pandemic. The results imply that both targeted policies and conventional countercyclical fiscal and monetary policy can accelerate the economic recovery. Large demand shocks highlight an environment of deficient demand with countercyclical policy calibrated to the size of these shocks.
What Has Been the Impact of COVID-19 on Debt? Turning a Wave into a Tsunami (November 2021)
This paper presents a comprehensive analysis of the impact of COVID-19 on debt, puts recent debt developments and prospects in historical context, and analyzes new policy challenges associated with debt resolution. The paper reports three main results. First, even before the pandemic, a rapid buildup of debt in emerging market and developing economies—dubbed the “fourth wave” of debt—had been underway. Because of the sharp increase in debt during the pandemic-induced global recession of 2020, the fourth wave of debt has turned into a tsunami and become even more dangerous. Second, five years after past global recessions, global government debt continued to increase. In light of this historical record, and given large financing gaps and significant investment needs in many countries, debt levels will likely continue to rise in the near future. Third, debt resolution has become more complicated because of a highly fragmented creditor base, a lack of transparency in debt reporting, and a legacy stock of government debt without collective action clauses. National policy makers and the global community need to act rapidly and forcefully ensure that the fourth wave does not end with a string of debt crises in emerging market and developing economies as earlier debt waves did.
Last Updated: Mar 12, 2023
