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A sl uggish global economic outlook, with slower growth in the 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 Global Economic Prospects and the Developing Countries 2003: Investing to Unlock Global Opportunities, uncertainties in global financial markets have sapped the momentum of the modest recovery that began in late 2001. The report outlines steps that rich countries and developing countries can take in the current uncertain environment to increase growth rates and speed poverty reduction in developing countries.

Slower Global Growth Undermining Poverty Reduction

After exceptionally slow growth in 2001 and 2002, global GDP is now expected to rise by 2.5 percent in 2003, higher than the previous two years but still well below the 3.9 percent 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, World Bank Chief Economist and Senior Vice President for Development Economics.

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

Private Capital Flows to Developing Countries Down Sharply

The sagging global economy has reduced private capital flows to developing countries. Net commercial bank lending has turned negative, and 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 percent 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 Enron and 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 projects3❄4 such as in power, roads or water system3❄4 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.

Action on Doha Trade Agenda More Important Than Ever

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 trade barriers and other impediments to investment and 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 U.S. farm bill and the recently announced accord to maintain E.U. spending on farm subsidies until 2013 have complicated agricultural talks," says Dadush. 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 increased market access and new protections against adverse government policies, such as expropriation. However, the report finds that a global agreement to add new investor protections against adverse government policies would probably do little to increase FDI in developing countries.

According to Global Economic Prospects 2003, an investment agreement could potentially help developing countries3❄4 but only if it takes up the issues with the largest development impact such as removing investment-distorting trade barriers facing developing countries' exports. Developing countries in general face external barriers to their trade in manufactures that are twice that of rich countries. The report enumerates many of these barriers, including for example, tariff escalation. Fresh Chilean tomatoes exported to the US pay a tariff of 2.2 percent; if they are dried and put in a package they have to pay 8.7 percent, and if they are made into ketchup or salsa they have to pay nearly 12 percent. These barriers discourage domestic and foreign investment alike.

"Removing 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 domestic regulatory issues without getting this big picture right risks delaying an agreement or producing outcomes that don't really help poor people."

One barrier to competition described in the report that does hurt developing countries but has received relatively little public attention is international cartels, 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 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 maritime transport, are officially exempt from anti-trust laws. Bank research cited in the report found that breaking up price fixing arrangements among private shipping lines could reduce maritime transport prices by about 20 percent, saving 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 developing countries that have been adversely affected by cartels to sue in rich country courts.

Improving the Investment Climate in Developing Countries

Even in a sluggish global economy, developing countries can do much on their own to promote growth and poverty reduction. While previous Bank studies emphasized good governance, sound institutions, and property rights as necessary conditions to produce greater quantities of private investment, both domestic and foreign, this year's Global Economic Prospects 2003 goes further by considering policies to promote competition as a way of improving the quality of investment, that is, making investment more productive.

The report analyzes policy barriers that limit competition in developing countries: trade barriers can prevent import competition; legal restrictions can prevent foreign entry that would increase the number of competitors; state monopolies can prevent entry of private firms, 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 consumers.

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

Similarly, although privatizations often have contributed to growth and poverty reduction, privatization itself is no panacea and may not improve outcomes when competition is lacking and the post-privatization regulatory regime is weak. "Simply transforming a state monopoly into private monopoly squanders the potential of privatization," says Newfarmer. "The real benefits from priviatization come from introducing competition to drive productivity improvements and regulations that provide poor people with access to services."


In Africa, for example, telephone service in countries with competitive networks has expanded three times faster than in 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 percent higher than in Thailand - World Bank.

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