Introduction
Justin Yifu Lin has been the World Bank’s chief economist since June 2008. He is the first person from an emerging market to hold this role since the World Bank was founded over 60 years ago.
He was previously professor and founding director of the China Centre for Economic Research at Peking University. Lin, who received his PhD in economics from the University of Chicago in 1986, has written 16 books including The China Miracle: Development Strategy and Economic Reform, published in seven languages, and State-Owned Enterprise Reform in China, which is available in Chinese, Japanese, and English. Among his public roles in China, Lin has served as a deputy of China’s People’s Congress and Vice Chairman of the All-China Federation of Industry and Commerce. He has also served on international task forces and groups including the United Nations Millennium Task Force on Hunger, the National Committee on United States–China Relations; the Working Group on the future of the OECD (Organization for Economic Co-operation and Development) and the Reinventing Bretton Woods Committee. He gave the 2007–2008 Marshall Lectures at Cambridge University.
Slowdown in Emerging Markets
As the world economy is buffeted by the worst financial crisis for many decades—a crisis that entails grave implications for developing countries and threatens to undo the hard-won gains in growth and development of the past years—the world needs international economic cooperation more than ever.
Until the summer of 2008, there was a view that the “decoupling” theory of global economics would prevail, ensuring that developing economies would remain mainly immune to the financial crisis and economic downturn that was sweeping through the developed world. Now, that looks like wishful thinking.
Developing countries, which like the developed nations had thrived on the back of the 2002–2007 global economic boom, have faced the triple jeopardy of food, fuel and financial crises. Many are entering a danger zone. The international community is going to have work together to overcome this crisis and prevent it from triggering a development and humanitarian crisis.
Developing economies are feeling the fall-out in a number of ways, with countries with high balance of payments and fiscal deficits being the most vulnerable. Many nations are facing a rapid decline in exports, as the runaway trade expansion of 2002–2007 has sharply slowed. Commodity exporters were among those hit hard, since the reversal in GDP growth was accompanied by a drop in prices for food, fuel, and metals.
The crisis also dealt a major blow to investment in emerging markets. Portfolio investment fell, as investors removed their capital or chose to keep it closer to home. Foreign direct investment, though historically more resilient to economic and financial shocks, will also decline.
In addition, developing countries which still had access to capital started having to pay higher interest rates for the privilege, owing to the flight to safety and greater risk-aversion among lenders. Also, as labor markets slacken, foreign workers have suffered a disproportionate impact on their earnings, with remittances falling as a share of GDP.
Second-round effects of the crisis are likely to deepen the slowdown. Because of the investment surge of the past five years, many investment projects are underway in emerging economies. As investment financing dries up, two outcomes are possible. In some cases projects may be mothballed, making them unproductive and saddling banks’ balance sheets with nonperforming loans. In other cases, once the projects are completed, they will add to excess production capacity, increasing the risk of deflation.
As a result of all these factors, developing countries’ collective GDP growth is expected to slow to 2.1% in 2009, compared with an average of more than 7% in 2004–2007. Meanwhile, high income countries are in deep recession this year, with OECD economies likely to contract 3% and other high income countries 2%.
This highly synchronous growth collapse cannot be solely explained by trade linkages, but illustrates also that developing countries have been directly hit in their domestic economies by the financial crisis. The reversal of capital flows, collapse in stock markets, and in general the deterioration in financing conditions have brought investment growth in the developing countries to a halt, and in many developing countries investment is sharply declining.
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