March 10, 2003	Monday	Muharram 6, 1424

A sluggish global economic outlook, with slower growth in next 12 to 18 months than previously anticipated, will impede poverty reduction in developing countries, according to a new World Bank report.

Action to remove barriers to trade and investment that hurt poor people in developing countries is becoming increasingly urgent. According to the Global Economic Prospects and the Developing Countries 2003, uncertainties in financial markets have sapped the momentum of modest recovery that began in late 2001. The report outlines steps that the rich countries and developing countries can take in the current uncertain environment to increase growth rates and speed poverty reduction in the developing countries.

After exceptionally slow growth in 2001 and 2002, the global GDP is expected to rise by 2.5 per cent in 2003, higher than the previous two years, but well below the 3.9 per cent expansion recorded in 2000 and significantly below long-term potential growth rates, according to the report.

The report warns that the global rebound might quickly lose momentum and there is a significant risk that the world could slip back into recession.

“The recovery has been much more hesitant and uneven than we had expected,” says Nicholas Stern, the World Bank Chief Economist and Senior Vice President for the Development Economics.

According to the latest forecasts, high-income countries are expected to grow at about 2.1 per cent in 2003. On average the developing countries will grow considerably faster, at 3.9 per cent. But the average masks wide regional differences, with the East Asia leading the pack at 6.1 per cent, followed by South Asia at 5.4 per cent. Other regions are expected to grow less than 4 per cent, with Latin America managing a mere 1.8 per cent. Outside of Asia and Eastern Europe, the growth rates in most developing countries are too low to generate a marked reduction in poverty.

According to the report, factors suppressing global growth in the near term include waning consumer confidence, high debt levels in the face of a weak equity market, and the fallout from corporate financial scandals in the US, continuing investor worries over imbalances in the Japanese banking system, and over investment in telecommunications and other high technology in Europe, as well as concerns about debt problems in Latin America.

The sagging global economy has reduced the private capital flows to developing countries. The net commercial bank lending has turned negative, and the foreign direct investment flows to developing countries have fallen since their peak in 1999. “We’re looking at the most sustained fall in foreign direct investment in developing countries since the global recession of 1981-83” says Richard Newfarmer, lead author of the report.

Private foreign investment in infrastructure is down 25 per cent from 1997 in developing countries. Investors are becoming averse to long-term projects; accounting scandals in industrial countries have driven from the market major players such as the Enron and the Worldcom; and slower growth in East Asia, Russia and Brazil has reduced investment demand.”Beyond the macroeconomic difficulties this retrenchment imposes, attracting private domestic and foreign investment to infrastructure is essential for development,” says Newfarmer. “But in the current environment, many important projects such as in power, roads or water system simply won’t be able to attract the necessary private capital.”

Not only is there less investment, but investors are more discriminating. Investment in developing countries is being redirected to countries with better investment climates. Uri Dadush, Director of the Bank’s International Trade Department, says that the slowing global economy threatens to distract attention from the need for rapid progress in global trade talks. “It would be unfortunate indeed if a myopic focus on short-term issues permitted protectionist forces to stifle progress in removing the trade barriers and the other impediments to investment and the poverty reduction in developing countries,” he says.

Global trade talks launched at Doha in November last year to address the needs of developing countries are showing signs of becoming bogged down. “The US farm bill and the recently announced accord to maintain the EU spending on farm subsidies until 2013 have complicated agricultural talks,” says Dadush. The World Trade Organization (WTO) ministers plan to review progress at the next global trade summit, in Cancun, Mexico, in September 2003.

The Cancun meeting will have to take up, among other things, two new controversial issues, a proposed international investment agreement and requirements for competition policy. Multinational corporations hope such an agreement would provide them with the increased market access and new protections against adverse government policies, such as the expropriation.

However, the report finds that a global agreement to add new investor protections against adverse government policies would probably do little to increase the FDI in developing countries.

According to the Global Economic Prospects 2003, an investment agreement could potentially help developing countries but only if it takes up the issues with the largest development impact such as removing the investment-distorting trade barriers facing the developing countries’ exports. The developing countries in general face external barriers to their trade in manufactures that are twice that of the rich countries. The report enumerates many of these barriers, including for example, the tariff escalation. Fresh Chilean tomatoes exported to the US pay a tariff of 2.2 per cent; if they are dried and put in a package they have to pay 8.7 per cent, and if they are made into ketchup or salsa they have to pay nearly 12 per cent. These barriers discourage domestic and foreign investment alike. “Removing the barriers to trade and investment that hurt poor people in developing countries should continue to be the main focus of global trade talks, this includes barriers in the rich countries and in the developing countries themselves,” says Stern. “Straying too far into the domestic regulatory issues without getting this big picture right risks delaying an agreement or producing the outcomes that don’t really help poor people.”

One barrier to competition described in the report that does hurt the developing countries but has received relatively little public attention is the international cartels — groups of large companies, usually based in rich countries that agree among themselves to fix prices and allocate export markets. Six international cartels prosecuted in the 1990s are estimated to have over-charged the developing countries a total of about $3 to $7 billion.

The cartels covered products such as vitamins, citric acid and stainless steel tubes.

Some cartels, such as the maritime transport, are officially exempt from the anti-trust laws. Bank research cited in the report found that the breaking up of price fixing arrangements among the private shipping lines could reduce the maritime transport prices by about 20 per cent, saving the developing countries at least $2.3 billion per year on their import costs.

The report proposes greater information disclosure and stronger enforcement mechanisms to prevent such abuses. It also recommends allowing the developing countries that have been adversely affected by cartels to sue in rich country courts.

Even in a sluggish global economy, developing countries can do much on their own to promote growth and poverty reduction. While the previous Bank studies emphasized on good governance, sound institutions, and property rights as the necessary conditions to produce greater quantities of private investment, both domestic and foreign, this year’s Global Economic Prospects goes further by considering policies to promote competition as a way of improving the quality of investment — that is, making the investment more productive. The report analyzes policy barriers that limit the competition in developing countries: trade barriers can prevent import competition; legal restrictions can prevent foreign entry that would reduce the number of competitors; state monopolies can prevent the entry of private firms, the foreign and domestic alike; and badly-designed regulatory regimes in industries that have been privatized can impede both domestic and foreign competitors, to the detriment of the consumers.

Addressing one area without addressing others can produce perverse results: for example, permitting the foreign entry behind high tariffs can create the foreign-dominated oligopolies that reduce the national income. But lowering of trade barriers can help compete away monopoly profits. According to the report, the increasing imports in concentrated industries from zero to 25 per cent of the domestic sales reduces the oligopoly profit mark-ups by 8 per cent through lower prices to consumers. Firms in Korea, Malaysia and Thailand are more productive than the firms in India and China, in part because of lower trade restrictions and the administrative barriers to entry.

Similarly, although privatizations often have contributed to growth and poverty reduction, privatization itself is no panacea and may not improve the outcomes when competition is lacking and the post-privatization regulatory regime is weak. “Simply transforming a state monopoly into a private monopoly squanders the potential of privatization,” says Newfarmer. “The real benefits from the privatization come from introducing competition to drive the productivity improvements and regulations that provide poor people with access to services.”In Africa, for example, the telephone service in countries with competitive networks has expanded three times faster than in the countries with private telephone monopolies. Improving the quality of infrastructure and its management can improve the competitiveness of exports. For example, India’s shipping costs to the US are more than 20 per cent higher than in Thailand.